Elasticity of Demand 3b PDF

Rubor Acaey feonomics 8291 00 I| 22 Chapter Elasticity...

Rubor Acaey feonomics 8291 00 I| 22 Chapter Elasticity of Demand 3b lntroduction. The law of demand shows that there is an inverse relation between price and quantity demanded i.e. when price falls demand rises and when price rises demand is falls. The law of demand does not explain the extent of change in demand due to a change in price. ln other words the law of demand fails to explain quontitative relationship between price and demand. Hence, Dr. Alfred Marshall explained the concept of elasticity of demand. MEANING SIMPLIFIED The term elasticity means responsiveness or sensitivity. The concept of elasticity of demand measures the responsiveness of quantity demanded to a change in price. Elasticity of demand explains how much expansion or contraction of demand takes place due to fall or rise in price. Definition of Elasticity of Demand: "Elasticity of demand is great or small according to the amount demanded which increases much or little for a given fall in price, Prof. Marshal and Guantity demanded decreases much or little for a given rise in price." "Price elasticity is a concept for measuring how much the Prof. P.A, Samuelson quantity demanded responds to changing_ price. -cONCEPT OF ELASTICITY OFDEMAND 1. Explain the concept of Elasticity of Demand. Ans The term elasticity means responsiveness or sensitivity. The concept of elasticity of demand measures the responsiveness of quantity demanded to a change in price. 2. Accordina to Prof. Marshall's definition, (Elasticity of demand is great or small according to the amount demanded which increases much or little for a given fall in price, and quantity demanded decreases much or little for a given rise in price. 3. According to Prof. P.A. Samuelson definition, "Price elasticity is a concept for measuring how much the quantity demanded responds to changing price." Roben'sAndensy I| 22 829) 00 Econonics a technical term is 4. of demand Therefore, it is clear from the above definitions that elasticity or rise in fall demanded to a which describes the responsiveness of change in the quantity its price. Guantitu demanded of a commodity to of percentage chanoe in S. it is the ratio 1m other words, a percentage change in its price. TYPES OF ELASTICITY OF DEMAND 2. Explain the concept of Price Elasticity of Demand. Ans of demand is a ratio of proportionate Marshall, "Price elasticitu Hccording to Prof. Alfred to a qiven proportionate change n 5 demanded of a commodity changes in the quantity price," to a change in price onlg 2. responsiveness of chanoe in demand due elasticity is Ihus, price ana habits, fashions, prices of substitute other factors such as income, population tastes, goods are assumed to be constant. complementary of demand is written as 3. Therefore, price elasticit demanded d= Percentage Percentage change in quantity change in price Ed = AQ/Q AP/P AP Where = Original Quantity demanded P = Oriqinal Price DQ = Change in Quantity demanded AP Change in Price infinite, zero, unit, qreater than one and less 9. Price elasticit of demand may have five values than one. 3. Explain the concept of Income Elosticity of Demand. Ans as the degree of responsiveness of quantity Income elasticity of demand may be defined demanded to change in income only. Other factors including price remain unchanged. change in quantity demanded 2. It is written as - Ey = Percentage Percentage change in incame 3. Symbolically it is written as - Ey %AQd %AY Where = Quantity demánded =lncome D[Delta] Change Elasticity of Demand 3b.2  829) 00 I) 22 Aea when demand increases with increasing income and 4. Income elasticity of demand is positive, with increase in income. negative when, quantity demanded decreases of demand is positive, whereas in case of inferior S. In case of normal goods income elasticity goods, income, elasticity of demand is neçative. 6 Income elasticity of demand can be zero, one, qreater than one and less than one. 4. Explain the concept of Cross Elasticity of Demand. Ans proportionate change in quantity Cross elasticity of demand may be defined os the ratio of A a given proportionate change in the price of commodity B. demanded of commodity to 2. Cross elasticity of demand is found in case of substitute goods as well as complimentary goods and non-related goods. Percentage change in quantity demanded of A 3. Symbolically - Ec= Percentage change in price of B Ec = %0QA %APB Ec = AQA APB PB Ec = X PB QA APB Where, = Original quantity demanded of commodity AQa = Change in quantity demanded of commodity P& =Original price of commodity B APs = Change in price of commodity B negative or 2ero. It is positiye in case of suhstitute gaods 4. Cross elasticity can be positive, case of complementary goods [Example, tea and [Example, tea and coffee], negative in and case of unrelated goods [Example, tea books). sugar] and 2ero in TYPES OF PRICE ELASTICITYOF DEMAND demand. [Mar 96, 10 l6 Oct 99, 02] OR 3Whot are the types of price elasticity of Explain different types of price elasticity of demand. Whot is Price Elasticity of Demand? [Mar 08 Oct 14] change in quantity demanded of a of demand refers to the percentage Ans- Price elasticity According P. A. Samuelson "Price commodity to a percentage changein its price. to Prof. how much the quantity demanded responds to changing elasticity is a concept for measuring price." Types of Price Elasticity of Demand 3b.3 Elasticity of Demand  eeneet I. Infinite /Perfectly 824) 00 H 22 Elastic Demand When a slight or zero change in the price brings about on infnite demanded change in the quontity of that commodity, it is called perfectly b. Perfectly elastic demand. elastic demand is only a theoretical C. possibility. For example, 10% fall in price may lead to an infinite rise in demand. d. Ed = Percentage change in Quantit Demanded /Percentage change in Price e. When demand is infinite elastic, demand curve is horizontal straioht line parallel ta XaXis. f. Symbolically Ed=. Pice 2. Perfectly lnelastic Demand a. When a percentage change in priçe has no effect onthe quantity demanded of acommodity it is called perfectly inelastic demand. b. For example, 20% fall in price will have no effect on quantity demanded. C. Ed = %AQ / % AP Ed =0 20 / =0 d. In practice, such a situation rarely occurs. For example, demand for salt, milk. e. When demand is perfectly inelastic the demand curve is represented by a vertical straight line parallel to Y axis as shown in diagram. f. Symbolically, Ed=0. 3. Unitary Elastic Demand Elasticity of Demand 3b.4  a. When the percentage change in quontity demanded is exactly equal to the percentage in price, it is said to be unitory elastic demend. b. For example, SO% fall in price of a commodity leads to s0% vise in quantity demanded. c. Ed = %AQ/ AP % Ed = S0% S0% =| / d. For eg. price falls by So% from OP to OP, and quantity demanded also rises by S0% from 0Q to OQ. e. When the demand curve slopes steadily towards the X axis or a is rectangular hyperbola demand is unitary elastic. f. Symbolically, Ed=l. 4. Relatively Elastic Demand a. When a percentage chonge in price leads to more than proportionate change in quantity demanded, the demand is said to be relatively elastic. b. for example, S0% fallin price leads to7S% rise in quantity demanded. c. Ed = %AQ/ % AP Ed = 7S% / S0% = 15 d. If price falls by s0% from OP OP, the demand to will rise by 75%, ie., greater than percentage change in price from 0Q to 0Q. c. Slope of demand curve in this case will be relatively flat. d. Symbolically, Ed >l. of Demand 3b.5 Elasticity  S. Relatively lnelastle Demand a. Dhen a percentage chonge in pice leods to less than poportonate change in the quantny demanded, demand is sold to be rolatively melastc. b. For example, so% fall in price leods to 25% vise n quantMy domanded C. Ed = %AQ /% AP Ed = 2S% S0% = 0.5 / d. Forexomple, if price falls by S0% from 0P to 0P, the demond will hse by 25%,ie, leos than percentage chonge n price from 0Q to 09 e. Slope of demond curve in this case steeper, f. Symbolically, Ed | 20 160 12 120 Inelastic or < l 12 e. Unitary Elastic Demand- When price falls or rises, total expenditure does not change or remains constant, demand is unitary elastic. ln the above table, in example A, price falls from 10to 8 but the total expenditure remains constant. f Elastic Demand - When price falls, total expenditure increases or price rises and total expenditure decreases, demond or is elastic elasticity of demand is greater than one. In the above example B, price table, in falls from 10 to R 8 and total expenditure rises from 120 to 160. Inelastic Demand - When price falls and total expenditure decreases or price rises and total expenditure increases, demand is inelastic or of demand elasticity is less than one, In the above table, in example B, price falls from l0 to 3 andtotal expenditure falls from 120 to 12. FACTORS DETERMINING ELASTICITYOF DEMAND 8. 1What is elasticity of demand ? Explain the factors determining elasticity of demand. [Mar IS] Elasticity of Demand 3b.9  829) 00 I) 22 Hns - The term elasticity means responsiveness or sensitivity. The concept of elasticity of demand measures the responsiveness of quantit demanded to a change in price. Following are the foctors determining elasticit of demand - Nature of Commodities - Elasticity of demand depends upon nature of commodity. Commodities may be either necessaries or luxuries. Normally, elasticity of demand for necessaries is inelastic and for luxurious demand tends to be elastic. For e.g.-Necessary goods - Rice and dal are necessary goods & Luxury goods - Pizza 2. Durability- Durability of goods is also a factors determining elasticity of demand. The demond for durable goods is elastic. For e.g. - Washing Machine. Demand for perishable goods is inelastic. For e.g. - Fruits and vegetables. 3. Substitute Goods - Availability of substitutes also determines Elasticity of Demand. If a commodity has many substitutes in the market, demand tends to be more elastic. For e.9. - Soft drinks. Commodity with less or no substitutes has inelastic demand. For e.g. - Salt 4. Uses of a Commodity - When commodity can be put to several uses, its demand is elastic. The demand for electricity is elastic. For e.g. - Electricity can be used for cooking, heating, cooling etc. S. Price level - Goods, which are very highly priced ldiamonds, Mercedes] or very low price salt, match box] normally tend to have inelastic demand. 6. Habits - Habits also influence Elasticity of Demand. The demand, which satisfy the habits, is normally inelastic. For e.g. the demand for cigarettes is inelastic for a smoker. Income of Consumer - When income level is high demand, is normally inelastic. For e.g. - Demand for a billionaire will always be inelastic. Demand is elastic if the level of income is very low. For e.g. Demand for a middle class or a lower class person with a lesser income is elastic. Proportion of lncome Spent - When proportion of income spent is large, then the demand for qoods tend to be inelastic. For e.g. - demand for food grains is inelastic. If the amount spent is a smallamount of their income spent on certain qoods, then the demand is elastic in nature. Conmplementary Complementary Goods - The demond for complementary goods is inelastic. the price of petrol rises, Q0ods such as motor car and petrol are demandedjointly. So even if its demand does not respond in a large way. SIGNIFICANCEOF PRICE.ELASTICITYOF DEMAND significance of concept of Price Elasticity of Demand. [Mar 00, 9. Explain the importance / 03, 04, 0S] 3b.10 Elasticity of Demand  Econaics 829) 00 ) 22 Ans - The term elasticity means responsiveness or sensitivity. The concept of elasticity of demond measures the responsiveness of quantity demanded to a change in price. Price Elasticity of Demand in practically important due to following foctors: Monopolyond Elasticity of Demand - The objective of a seller in monopolymarket is profit maximization. Since he is a single seller having total control over the market, supply of goods and price, he can take decisions about price polic and get more profit. If demand is inelastic for the product sold by monopolist, he will raise the price of that commodity thereby earning more profit. 2. Taxation Policy and Elasticity of Demand - The concept of Price Elasticity of Demand is useful to the government in determining taxation The policy. finance minister cOnsiders the Elasticity of Demand, while selecting Q0ods and services for taxation. If Qovernment wants more revenue, then those qoods will be taxed more, for which demand is inelastic. Therefore, heavy taxes are imposed on goods like cigarettes and liquors which have inelastic demnand. 3. Fixation of Wages and Elasticity of Demand - The concept of Elasticity of Demond is useful to trade unions in collective barqaining, for wage determination. When trade union leaders know that demand for their product is inelastic, they will insist for more wages to workers. 4. International trade and Elasticity of Demand- The concept of Elasticity of Demand is useful to determine norms and conditions in trade. international If a country is exporting commodities for which demandis inelastic, they can raise the prices. For instance, Organization of Petroleum Exporting Countries [OPEC] has increased the prices of oil several times. The concept is also useful in formulating export and import policy of a country. S. Public Vtilities In case of public railways whose utilities like demand is inelastic, in order to avoid consumner's exploitation, the government can either subsidise or nationalise them. This shows need of governmentmonopoly. Elasticity of Demand 3b.ll