B.

Com (P), sem-V

PRACTICE ( PRICE ELASTICITY OF DD)
I. When price of a good is 13 per unit, the consumer buys 11 units of that good.
When price rises to 15 per unit, the consumer continues to buy 11 units.
Calculate Price Elasticity of Demand. 0
II. A consumer buys 10 units of a good at a price of 6 per unit. Price Elasticity of
Demand is (-) 1. At what price will he buy 12 units? 4.8
III. When price of a good is 12 per unit, the consumer buys 24 units of that good.
When price rises to 14 per unit, the consumer buys 20 units. Calculate Price
Elasticity of Demand. 1
IV. A 5% fall in price of a good leads to 10% rise in its demand. A consumer
buys 40 units of a good at a price of 10 per unit. How many units will he buy at
a price of 12 per unit? 24
V. A 5% rise in price of a good leads to 5% fall in its demand. A consumer
buys 100 units of a good when price is 5 per unit. At what price will he buy
120 units? Calculate. 4
 Elasticity of Demand and Supply 2.3
2.2 FACTORS AFFECTING PRICE ELASTICITY OF DEMAND
The factors which detemine the price elasticity of demand for a commodity or
service are:

1. Availability of Close Substitute: A good having close substitutes will

have an elastic demand and a good with no close substitutes will have
an inelastic demand. Example: commodities such as pen, cold drink,
car, etc. have close substitutes. When the price of these goods rise, the
price of their substitutes remaining constant, there is proportionately
greater fall in the quantity demanded of these goods. That is, their demand
is elastic. Commodities such as prescribed medicines and salt have no
close substitutes and hence, have an inelastic demand.
2. Income of the Consumers: If the income level of consumers is high.
the elasticity of demand is less. It is because change in the price will not
affect the quantity demanded by a greater proportion. But in low income
groups, elasticity of demand is high.
3. Luxuries versus Necessities: The price elasticity of demand is likely
to be low for necessities and high for lhuxuries. A necessity is a good
or service that the consumer must have such as food (bread, milk) and
medicines. Luxuries are goods that are enjoyable but not essential.
in a 5-star hotel. If the price of
Example: travelling by air, eating
necessities rise, then demand will not fall by a greater proportion because

their purchase cannot bedelayed. That is why, the price elasticity of

demand in case of necessity is low.
on the Product: Higher the
4 Proportion of Total Expenditure Spent
cost of the good relative to
total income of the consumer, more will be
of bread, ink, salt, match box,
the price elasticity of demand. If the price
doubles it would have almost no effect on
etc., which is relatively low,
the other hand, if price of car doubles
the quantity demanded of them. On
then the quantity demanded will fall by a greater proportion showing high
price elasticity of demand.
The more the number of uses a
5. Number of Uses of the Commodity:
more elastic is the demand. If a commodity
commodity can be put to, the
inelasticedemand. Examples: goods like milk, eggs
has few uses, it has an
different uses and hence, enjoy elastic
and electricity can be put to many
are low, demand increases by a greater
demand, i.e., when prices
can now be put to less important uses also.
proportion as the goods
time period needed to find substitues of the commodity
6. Time Period. If the
demand is less and vice versa. Example:
is more, the price elasticity o/
substitutes available for petrol. It has an elastic
today there are many
 Microeconomics
2.30 Principles of

3000 D

4500 E
B.Com., Semester V (CBCS), 2017n

Solution.
Point P .
B
7 1,000

D
5 3,000

AQ P 2000
,for Bto D-aP2 11
1000

AQ P2000 51.6
e for D to B= AP 2 3000

Arc ee
Arc Midwy e, | a . + P
or Midway =
or
eaAP +0
2000 12
2 4000
. 3

2.9 INCOME ELASTICITY OF DEMAND

2.9.1 Meaning of Income Elasticity of Demand

The income elasticity is a
quantitative measure of the degree to which quantity
demanded responds to a
change in income, ceteris paribus. Income elasticiy
of demand
(hy) calculated as the percentage change in quantity demanded
is
due to
pereentage change in income. That is,
% change in quantity demanded
% change in income

AQ Y
,AY Q2
where
Y =
Initial income
Q Initial quantity demanded
AQ = Change in quantity demanded
 Elasticity of Demand and Supply 2.31
AY Change in income
Coefficient of income elasticity of demand
Income Elasticity: The income
asthe percentage elasticity of demand is ealculated
change in quantity demanded due to percentage
change in incomne.

2.9.2 Types of Income Elasticity of Demand

Income elasticity can be positive
different values. These are:
or
negative. Income elasticity can take five
1. Greater than One
This occurs when the percentage
change in quantity demanded is greater than the
percentage change in income. It is called high income elasticity. It takes
in case of luxury goods. place
2. Equal to One
This occurs when the
percentage change in quantity demanded is
percentage change in income. II is called unitary income elasticity.equal
to the
It holds for
those nomal goods which fall between the
category of necessities and luxuries.
3. Less than One
This occurs when the
percentage change in quantity demanded is less than the
percentage change in income. It is called low income
elasticity. This takes place
in case of necessities.
4. Equal to Zero
This occurs when there in no change in quantity demanded with change in income.
It is called zero income
elasticity. It is difficult to specify the kind of good
where e is zero. However, the goods fall between the category of a necessity and
an inferior good.
5. Less than Zero
This occurs when the percentage change in quantity demanded is negative with
change in income. It is called negative income elasticity. It holds in case of
inferior goods.
Table 2.9 surmmarises the five different values of income elasticity.
Table 2.9 Different Values of Income Elasticity of Demand
Type of Good
Value of e, Terminology

e,>1 High Income clasticity Luxury good

Normal good which is a necessity as well
e, Unitary income elasticity
as semi-luxurious

Necessity
0<e<1 Low Income elasticity quality necessity
Zero Income elasticity Can be a poor
0
Inferior Good
Negative Income elasticity
2.32 Principles of Microeconomics

2.9.3 Graphical Representation or Income Elasticity

Income elasticity of demand 1s graphicalily shown by Engel's curva

Erast Engel. Ernst Engel

used this establish a
device to after
systematie relationshin
between household income and expenditure on commodities. Engel's

is shown in Fig. 2.16

Quantity

Engel's cuve

,0 e,<0
O Y Y2 Income
Fig. 2.16

Fig.2.16 Enge>'s Curve showing e,

In the figure,
Between origin and Y, =
The range of Engel's curve between origin till Y,
income level shows that
nothing is demanded at
income less than Y,. So,
e, 0 for income less than
=

Between Y, and Y, =
Between incomes of Y, and
Y,, as income rises
quantity demand rises. It implies e,>0 and the good
is a normal
good. A normal good can be a necessity
or a luxury.
Beyond Y, Beyond income level Y,, quantity demanded falls as
income rises. It shows e < 0 and the good is an
inferior.
2.10 CROSS
ELASTICITY OF DEMAND
2.10.1 Meaning of Cross Elasticity of Demand
ne
cross-elasticity of demand (e) is a
quantity demanded of good x due to quantitative measure
of the ettecr on a
t is a
change in price of good 2.
a
4re the responsiveness of the quantity demanded of x to a perce
I

Cnange in the price

of z. The cross-elasticity between two goodsa
calculated as:
% change in quantity demanded ofx
% change in price ofz
 Demand and Supply 2.33
Elasticity of

AP, .
where

P =
Initial price of good z

x
Initial quantity demanded of good
e, =

Change in quantity demanded of good x

AQ, =

AP, = Change in price of good

of demand
e Coefficient of cross-elasticity
or
of Demand: It is measure responsiveness
of the
Cross Elasticity a
the price of z.
the quantity demanded of x to a percentage change in

2.10.2 Types of Cross Elasticity of Demand

from minus infinity to plus infinity.
The valus of cross-elasticity ranges
to). The various values of cross elasticity of
demand are:
( se
(a) Greater than Zero (e > 0)
substitutes. The higher the numerical
This when the two goods x and z are
occurs
of substitutability. If e oo, then x and z are =

value of e , the greater the degree

on the e explains the positive relationship
perfect substitutes. The positive sign the
and the quantity demanded of its substitute. If
between the price of a good
demanded of its substitute, coffee, will fall.
price of tea falls then the quantity and coffee is positive.
between tea
elasticity
Thus, cross

(b) Less than Zero (e < 0)

z are complements. The lower the numerical
This occurswhen the two goods x and
the degree of complementarity. If e - o then x and =

value of e , the greater is

The negative sign on the e explains that when the
z are perfect complements.
the quantity demanded of its complements moves in the
price of a good increases
the price of sugar ncreases, the quantity demanded of tea
opposite direction. If
between tea and sugar is negative.
will fall. Thus, cross elasticity

to Zero (e
=
0)
c) Equal
x and z are unrelated. That is, a change in the
This when the two goods
occurs
not alrect n e quantuty demanded of the other good.
price of one good does
of demand is summarised in Table 2.10
Types of cross elasticity
2.34 Principles of Microeconomics
Table 2.10 Values of e
S.No. Value of e Relationship between x anddz
x and z are perfect compiements
x and z are complements
= 0 x and z are unrelated

4 x and z are substitutes

e,
x and z are perfect substitutes

2.11 SOLVED NUMERICAL PROBLEMS

ustration 1.
Calculate cross price elasticity of demand between

(a) Inkpen and ballpen

(b) Inkpen and ink

Good Before After

Price Quantity Price Quantity
(Rs./unit) (unit/months) (Rs./unit (unit/months)
Inkpen ( 15 2 20
Ballpen (X) 10 1 8
Inkpen (Z 10
Ink (X 15 5 10

Solution.

AQ (-2)=
exAP Q (-3) 10
+0.33 =

e AQ -)4=-1.33
AP, . (1) 15
Since ey 1s positive, inkpen and ballpen are substitutes. Since e, is negative
inkpen and ink are
complements.
Illustration 2
Calculate cross twice elasticity of demand
between:
(a) Wheat (X) and (b) Rice (Y)
 Elasticity of Demand and Supply 2.35

Good Before After

Price Quantity Price Quantity
(Rs./kg) kg/week) (Rs./kg) kg/week)
Rice () 40 50 60 30

Wheat (X) 20 40 20 50

Solution.

10 40= +0.5
20 40

Since e is positive, goods X and Y are substitutes.

(b) Wheat (X) and curd (Z)

Good Before After

Price Quantity Price Quantity
(Rs./kg) (kg/week) (Rs./kg) (kg/week)
Curd () 10 20 20 15
Wheat (X) 20 40 20 35

Solution.

exz 49.P
AP Ox
-5 10
+10 40
=-0.12
Since e is negative, goods X and Z are complements.
Illustration 3
The consumer
monthly income () is Rs. 1000, demand (Q)
is for 10 units of apple.
Ifthe monthly income increases (Y,) to Rs. 2000, demand increases (Q) to 18 units
of
apple. What will be income (Y) elasticity of demand for apple?
B.Com., Semester V, 20171
Solution.
Given:
Y = 1000
10
Y, 2000 e , -18
2.36 Principles of Microeconomics

.Y
AY
8 1000 0 , 8
1000 10
Since e 1, the good (apple) is a necessity

Wustration 4

Suppose, when price of Pepsi is 20 Rs. per bottle then

demand for Coke is 4
then demand for Coke
bottles. price of Pepsi rises to 25 Rs. per bottle,
If goes
be the cross elasticity of demand for Coke?
up to 50 bottles. What will
[B.Com, Semester V, (CBCS) 20177

Solution.
Given:
Ppepsi 20 Coke 40
= 25 Coke 50

Cross e AP Q
10 20
+1
40
Since cross elasticity is greater than zero, coke and pepsi are substitutes.
llustration 5
When your monthly income (Y) is Rs.
3,000, your demand (Q) is for 10 units of
ice cream. If your monthly income
increases (Y,) to Rs. 6,000, your demand
increases (2) to 30 units of ice cream. What will
be income elasticity of demand
for ice cream?
[B.Com., Semester V, (CBCS) 2018
Solution.
Y 3,000, Q = 10
Y, 6,000, , 30

AY

20 3,000
= 2
3,000 10
Illustration 6
Suppose, when price of coffee
is Rs. 5
It price of per cup then demand for tea is 50
coffee rises to Rs. 7
per cup, then demand for tea cu
goes up to 100 co
 Elasticity of Demand and Supply 2.37

the cross elasticity of demand for tea?

What will be
B.Com., Semester V, (CBCS) 2018
Solution.

P 5. , =50
P. =
7. 2 100 =

AQ
Cross e AP 2

s0 5
2 50
2.5
is greater than zero, tea and coffee are subsititutes.
Since cross elasticity

ELASTICITY OF SUPPLY
2.12 MEANING OF PRICE

of supply is defined as of quantity supplied of a

the responsiveness
Elasticity
The value of elasticity of supply will give
commodity to change in its own price.
to a change in price.
the degree or quantity of change in supply
It is calculated as:

Percentagee change in quantity supplied

es Percentage change in price

AQ

where,
e
= Coefficient of price elasticity of supply
P = Initial price of the good

Q Initial quantity supplied

AQ= Change in quantity supplied
AP Change in price
De posiive sign indicates that price and quantity supplied of a good are p o s "
at higher
units of the good will be placed in the market onty
L , greater
prices and vice versa.

2.13 FACTORS AFFECTING PRICE ELASTICITY OF SUPP Y

ne
important factors affecting price elasticity of supply are
elastic is the s p p e
me factor: The the time period, the more
longer
Curve.
 Paradox of Plenty: The paradox of
generally bring poverty plenty states that a
bumper harvest will
to the farmers.

2.8 SOLVED NUMERICAL PROBLEMSS

Ilustration 1. A 20% fall in the
price
of sugar leads to 25% rise in its
Calculate the price elasticity of demand. Comment on the demand.
Solution commodity.
Percentage change in quantity demanded
ep Percentage change in price
Thus, 25% = 1.25
ep 20%
Sugar has an elastic demand its coefficient of
as
elasticity of demand is greater
than one. Sugar is a
luxury for this household.
Illustration 2. When the price of wheat goes up
by 10% its demand falls from
800 units to 600 units. Calculate
price elasticity of demand. Will the demand
curve for wheat be flatter or steeper?
Solution: Given,
Original quantity ( ) = 800 units
New quantity ( ) = 600 units
Change in quantity (AQ) = 200 units
 2.20 Principles of Microeconomics

200
Percentage change in quantity =x100= 800 x100 25%

Percentage change in quantity demanded

Percentage change in price

25%
2.5
10%
Wheat has an elastic demand. It is a luxury for this household. The demand
curve
for wheat will be flatter showing more than
proportionate change quantity
in
demanded to a change in price.

Illustration 3. What is the

relationship between slope and elasticity of a demand
curve?

Solution: The förmula of elasticity of demand is

,-

Formula of slope of demand curve is:

Slope AQ
The relationship between slope and elasticity of a demand curve is

1
Slope
lustration 4. A consumer spends 7 40 on a
good at a price of 1 per unit and 7 60
at a price of 2 per unit. What is the
price elasticity of demand? What kind of good
it is? What shape its demand curve
will take?
Solution: Given,
Original price (P) = 7
New price (P) = 7 2
. Change in
price (AP) =
7 1|
From the expenditure (P x
) figures of 7 40 and 7 60,
figures can be calculated as follows: quantity demanded

Original quantity demanded (0) =

=
P
= 40units
 Elasticity of Demand and Supply 2.21

New quantity demanded (2) xQRs.60 30 units

RRe.2
Change in quantity (A) = 10 units.

AQ P_10 1
ep AP o T40 = 0.25
The good has an inelastic demand. It is a necessity like food, fuel etc. The
demand curve for this good is steep.
Illustration 5. Price of rice falls from7 5 to ? 4 per kg. This leads to an increase
in its demand from 10 kg to 20 kg in a month. Comment on its elasticity of demand.

Solution: Given,
P= 75 Q 10 kg
P 4
Q, 20 kg
AP= 1 AQ 10 kg

AQ P_10 5
AP T1o*
Rice has an elastic demand and is a luxury for this household.

llustration 6: What is price elasticity of demand for life saving drugs?

Solution: Life saving drugs are essentials. To a change in their price there can
be no change in the quantity demanded. That is e, - 0. Life saving drugs have a

perfectly inelastic demand.

Ilustration 7. A decline in the price of good Y by 7 5 causes an increase of 20
units on its demand which goes up to 50 units. The new price is 7 15.
Calculate ep
Solution:
AP 5 AQ 20 units
P=15 , 50 units

P 720 . Q 30 units

ep

Good Y has an elastic demand.

 2.22 Principles of Microeconomics

lustration 8. What will be the value of elasticity of demand if the demand

curve is a horizontal line parallel to x-axis?
Solution: This is a case of perfectly elastic demand, e, = o, In this situation,
percentage change in quantity demanded is infinity at a price.
Alternative Solution: On a horizontal demand

curve, slope ADIS zero.

ep
slope D

Px

llustration 9. Determine price elasticity of demand using percentage method.

Quantity Total outlay ()

20 100
30 120
Solution. Outlay means expenditure which is price multiplied by quantity
demanded. Thus, by dividing total outlay by quantity, price figures can be obtained
as follows:
and

Q 20 units
and PxQ =R 100

P. Px 100R
20. 5

Similarly, , 3 0 units

and Pe, -
7 120
 Elasticity of Demand and Supply 2.23

R120-Rs.
30 Rs.44
P = 7 5
Rearranging
P 4
AP 71
AP. 100
Percentage change in price =

x =
x100 = 20%

Also,
Q 20 units
30 units
AQ 10 units

AP 10
Percentage change in quantity-x100 20
x100 50%

Percentage change in quantity demanded

p Percentage change in price

50%
= -= 2.5
ep 20%
Illustration 10. As the price of a product decreases by 7%, the total expenditure
can we say about the elasticity of
demand for
on it has gone up by 3.5%. What

this product?
it is a case of elastic
Solution: Since with fall in price, total expenditure rises,
demand, i.e., e>1.
and the total expenditure
Illustration 11. The price of cauliflower goes up by 8%
8%. What can we say about the elasticity
by a family on cauliflower goes up by
of demand for cauliflower by this family?
of
Solution: Since with rise in price, total expenditure also rises it is a case

inelastic demand, i.e., e,<

? 300 for a and per
standard cleaning job
llustration 12. A dentist was charging
revenue equal to 30,000. She has since last month
month it used to generate total
to 350. As a result, fewer customers are
increased the price of dental cleaning From this,
but the total revenue is now ? 33,250.
now coming for dental cleaning,
of demand for such a dental service?
what can we conclude about the elasticity
 2.24 Principles of Microeconomics
Solution: Given,
P 300, Total revenue (P x
) =
7 30,000
P =
7 350, Total revenue (P, x
2) =
7 3,250

Therefore, when P = 300, Q = _30,00o 100

300

and when
P, =
7 350, 2,= Rx33,25095
PR 350

a 5300 3
eAP 50 100 100
Thus, demand for dental service is
inelastic since e, is less than one.
Illustration 13. Price of
its demand falls
goodX rises from 7 20 to 7 30 per unit. Consequently,
by 20 units and becomes 100 units. Determine
demand. price elasticity of
Solution: Given,
P =7 20 AQ = 20 units

P= 30
AP = 7 10
2, 100 units
120 units
20 20
.
ep AP10120=0.33
Ilustration 14. Calculate the elasticity of demand
by total expenditure method:
(a) Price () Total expenditure )
5
40
6
30
Solution. It is a case of e > 1 or elastic demand. It is defined
where with rise in
as a situation
a
price, total expenditure falls.
(b) Price () Total outlay (*)

40
6 40
 Elasticity of Demand and Supply 2.25
Solution: It is a case of e, =
1 because total
with a rise in price. expenditure remains unchanged

(c) Price () Total expenditure ()

5
40
6
50
Solution: It is a case of e, < 1 or inelastic demand since total
with a rise in price.
expenditure rises

Illustration 15. Originally, a product was selling for 7 10 and the quantity de
manded was 1,000 units. The product price changes to 14 and as a result the
quantity demanded changes to 500 units. Calculate the price elasticity.
Solution:
P= 10 Q 1,000 units
P= 14 , 500 units

AQ P 500 10
AP =1.25
4 1000=1.25

Illustration 16. Which of the following commodities have inelastic demand? Salt,
a particular brand of lipstick, medicine, mobile phone and school uniform.

Solution: Salt, medicine, school uniform have inelastic demand as they do not
have many substitutes. On the other hand, mobile phone and a particular brand of
lipstick has an elastic demand since they have many substitutes.

Tllustration 17. Letthe demand function be: Q= 10-2P. Find e a

5/2

Solution: = 10 - 2P Differentially Q with respect to P, we get AQ -2

AP

Also, when P= 5/2, Q = 10 -2 5

ep 0-2-2x=-J=1.
AP
 2.26 Principles of Microeconomics

nhustration 18. Let e, -0.4. By what percentage the quantity demanded goes
down if price of the good increases by 4%?

% change in quantity demanded

Solution:
% change in price

-0.41= change in quantity demanded

4
0.4 x 4 =
1.6
% fall
iaquantity demanded is 0.4 x 4 1.6%
Illustration 19. Let slope of demand curve 0.5 Calculate e, when initial price
= -

is 20 per unit and initial quantity is 50 units

of the commodity.
AP
Solution: Slope of demand curve =
0.

Slope AP 0.5

AP 0.5 50 H0.8 =
0.8

llustration 20. Explain the effect on expenditure if price of the good is raised
9% and e, is- 0.7. by
Solution: Since le,|
is 0.7, it is less than one. It is a case
of inelastic demand
showing lesser percentage change in quantity demanded.
Since price of the good rises
by 9%, it means quantity demanded falls
percentage than 9%. by a lesser
Thus, total expenditure rises.

Illustration 21. Given two demand

schedules, determine their elasticity of de-
mand using the total expenditure method.
P 4 3 2
200 210 230 255 300
200 260 370 600 1300
 Elasticity of Demand and Supply 2.27
Solution:
Calculating total expenditure for good A and good B, we get

P Total Expenditure Total Expenditure

on A on B

200 1000 200 1000

S
4 210 840 260 1040

3 230 690 370 1,110

255 510 600 1200
300 300 1300 1300

Therefore, good A (e, < 1) as expenditure fails with fall in

has inelastic demand

price. Good B has elastic demand (e,> 1) as expenditure rises with fall in price.

Ilustration 22.

1200
Let O,P
Prove that
good X remain unchanged as P, falls from 7 6 to
(a) Total expenditure on

1.
(6) Derive value of e, along the demand curve.

Solution:
1200
Total Expenditure
Points P Q,
P
M 200 1200
240 1200
N
300 1200

P 400 1200

2 600 1200

R 1200 1200

remain unchanged at 7 1200 when P, falls from 6 to Re

Thus, total expenditure

1200
(b) P
1200
P ,
=
2.28 Principles of Microeconomics
for any change P, in In other worde
h u s isexpenditure will ramain 7 1200 for
any percentage fall in P, O. will rise by
the same proportion or ep1 at eevery
point of the rectanular hyperbola, d.
Pa
Rectangular Hyperbola
showing e 1

Tlustration 23. Calculate point elasticity of demand at point M, at point N and

midway between point Mand N.

Reference points Px
(kg)
M 4
N 2 10

Solution:

Px
4
M Arc elasticity or midway elasticity

5 10

AQ P
efrom M to N = 5 4
AP O
5 2
e, from N to M
2 10=0.5
 Elasticity of Demand and Supply 2.29
The problem is that the same
pair of
price and quantity figures are giving two
differentvalues of elasticity.
Thevalue of elasticity
which elasticity is measured. To avoid depends on the direction in
this problem, the
values are averaged. The formula of arc price and quantity
elasticity of demand is:

Arc ep or
AQ PtPz
Pa-P9 +92 AP 41+2

1=1

Ilustration 24
Given two demand schedules, determine their
elasticity of demand using the total
expenditure method.
P 5 2

200 210 230 255 300

200 260 370 600 1300

Solution.
Calculating total expenditure for good and good B, we get:
Total Expenditure , Total Expenditure
on A on B

200 1000 200 1000

210 840 260 1040
230 690 370 1110

255 510 600 1200

300 300 1300 1300

Therefore, good A has inelastic demand (e, < 1) since expenditure falls with fall
rises with fali in
inprice. Good B has elastic demand (e,,> 1) as expenditure
price.

Ilustration 25
B point D and
Calculate price elasticity of demand for a movement from point
to

from point D to point B and midway between them.

. Point
P
0 A
8
1000 B
7
2000 C
6
 2.30 Principles of Microeconomics
3000 D

4500 E
6

B.Com., Semester V (CBCS),

Solution.
2017
Point
B 7 1,000
D 5 3,000

2.
e,for B toD = AP 2000
2 7
1000

e, for D to B =

AP 2 5=1.6
3000

Arc e or
Midway e, AQ.R+P
AP +2
2000 12
2 4000
= 3

2.9 INCOME ELASTICITY OF DEMAND

2.9.1 Meaning of Income
The income
Elasticity of Demand
elasticity is
quantitative
a

demanded responds to a change in measure of the degree to which quanuy

of demand (hy) is calculated as income, ceteris paribus. Income
the elasticny
percentage change
due in quantity demandcd
to
percentage change in income. That is,
% change in quantity demanded
%
change in income
AQ Y
,AY
where
Y =Initial income
Initial quantity demanded
AQ Change in quantity
demanded
 PRICE ELASTICITY OF DEMAND

Elasticity of Demand: three types

1. Price elasticity of Demand- The degree of responsiveness of quantity demanded to

changes in price of commodity is known as price elasticity of Demand. It is
quantitative statement, i.e., it tells us the magnitude of the change in quantity
demanded as a result of change in price.
2. Income elasticity of Demand- The degree of responsiveness of demand to change
in income of consumer is known as income elasticity of demand.
3. Cross elasticity of Demand- The degree of responsiveness of demand to change in
the price of related goods (substitute goods, complementary goods) is known as
cross elasticity of demand.

METHODS OF MEASUREMENT

Percentage Method/Flux Method for calculating price elasticity of

demand:
According to this method, price elasticity of demand is measured by dividing the percentage
change in quantity demand by the percentage change in price.
Note: Mathematically speaking, price elasticity of demand (ep) is negative, since the change
in quantity demanded is in opposite direction to the change in price. When price falls,
quantity demanded rises and vice-versa. But for the sake of convenience in understanding the
magnitude of response of quantity demanded to the change in price, we ignore the negative
sign and take into account only the numerical value of the elasticity. Thus, if 5% change in
price leads to 15% change in quantity demanded of good X and 30% change in that of Y, the
above formula of elasticity will give the value of price elasticity of good X equal to 3 and of
good Y equal to 6. It indicates that the quantity demanded of good Y changes much more
than that of good X in response to a given change in price. But if we write minus signs before
the numerical values of elasticities of two goods, that is, if we write the elasticities as – 3 and
– 6 respectively as strict mathematics would require us to do, then since – 6 is smaller than –
3, we would be misled in concluding that price elasticity of demand of Y is less than that of
X.
But as we have noted above, response of demand for Y to the change in price is greater than
that of X, it is better to ignore minus signs and draw conclusions from
the numerical values of elasticities. Hence by convention minus sign before the value of price
elasticity of demand is generally ignored in economics.

There are five degrees of price elasticity of demand.

(a) Unitary elastic demand: If percentage change in the quantity demanded is equal to
percentage change in price of the commodity, then ED = 1 and the result is known as unitary
elastic demand.
Negative sign indicates the inverse relationship between price and the quantity demanded.
PED = 1 [Unitary elastic demand]
(b) More than unitary elastic demand or elastic demand: If percentage change in quantity
demanded is more than the percentage change in price of the commodity then, ED > 1 and
result is known as more than unit elastic demand.

(c) Less than unitary elastic demand or inelastic demand: If percentage change in quantity
demanded is less than the percentage change in price of the commodity, then ED < 1 and the
result is known as less than unit elastic demand.
(d) Perfectly elastic demand: If quantity demand changes and price remains constant, then
ED = α and the result is known as perfectly elastic demand.

(e) Perfectly Inelastic demand: If price is changed ,and quantity demanded constant, then
ED=0 and the result is known as Perfectly Inelastic demand.
Total outlay method or Total Revenue Method or Expenditure
method

(a) Total expenditure method indicates the direction in which total expenditure on a product
changes as a result of change in price of the commodity.

(b) According to this method, there are three broad possibilities as shown below:

Case I: Inelastic Demand

(i) When the total expenditure (Total revenue) varies directly with price, price elasticity of
demand is less than one (i.e., demand is inelastic).
(ii) In other words, with the fall in price, total expenditure (Total revenue) decreases or with a
rise in price, total expenditure (Total revenue) increases.

Case II: Elastic Demand

(i) When the total expenditure (Total revenue) varies inversely with price, price elasticity of
demand is greater than one, (i.e. demand is elastic).
(ii) In other words, with the fall in price, total expenditure (Total revenue) increases, or with a
rise in price, total expenditure (Total revenue) decreases.
Case III: Unitary Price Elasticity
(i) When the total expenditure (Total revenue) remains the same, whatever may be the change
in the price level, price elasticity of demand is said to be unity.
Geometrical Method or Point Method

(a) According to point method, elasticity of demand at any point is measured by dividing
the lower segment of demand curve with the upper segment of the demand curve at
that point. It can be calculated by dividing the lower segment by upper segment.
Factors Determining Price Elasticity Of Demand For A Good

They are as follows:

1. Nature of commodity: Elasticity of demand of a commodity is influenced by its nature.
(a) The demand for necessities of life (commodities satisfying minimum basic needs) is less
elastic. They are required for human survival and they have to be purchased
whatever may be the price. Therefore, demand for necessities of life does not fluctuate much
with price changes.
(b) Whereas, demand for luxury goods is more elastic than the demand for necessities. When
the price of luxuries falls, consumers buy more of them and when the prices rises, demand
contracts substantially.
Please remember the term “luxury” is a relative term, as a luxury for a low-income
earning worker may be a necessity for rich employer.
2. Availability of substitutes/Substitute goods:
(a) If close substitutes for the commodity are available, the demand for the commodity will
be elastic. The reason is that even a small rise in its prices will induce the buyers to go for its
substitutes. For example, Pepsi and Coke are considered fairly close substitutes. If the price
of coke increases, Pepsi becomes relatively cheaper. Consumer will buy more of Pepsi and
less of relatively expensive Coke.
(b) However, the demand for a commodity (such as salt) having no close substitutes is
inelastic.
3. Income Level:
(a) Higher income level groups have less elasticity of demand for any commodity as
compared to the people with low incomes. It happens because rich people are not influenced
much by changes in the price of goods.
(b) But, poor people are highly affected by increase or decrease in the price of goods. As the
result of, demand for lower income group is highly elastic.
4. Level of price/Own price of a good:
(a) Higher own price of a good or Costly goods like car, gold etc. have highly elastic demand
as their demand is very sensitive to changes in their prices.
(b) However, demand for inexpensive goods like thread, needle etc. is inelastic as change in
prices of such goods do not change their demand by a considerable amount.
5. Postponement of Consumption:
(a) Commodities like ice cream, soft drinks, etc. whose demand is not urgent, have highly
elastic demand as their consumption can be postponed in case of an increase in their prices.
(b) However, commodities with urgent demand like life saving drugs, have inelastic demand
because of their immediate requirement.
6. Number of Uses:
(a) If the commodity under consideration has many alternative uses, its demand will be
highly elastic. For example, electricity.
(b) As against it, if commodity under consideration has only limited uses, its demand will be
highly Inelastic.
7. Share in Total Expenditure:
(a) If a smaller proportion of consumer’s income is spent on a particular commodity, its
elasticity is highly inelastic because lesser proportion of consumer income is spent on
consumption of these commodities. Demand for goods like salt, needle, etc. tends to be
inelastic as consumers spend a small proportion of their income on such goods. When prices
of such goods change, consumers continue to purchase almost the same quantity of these
goods.
(b) As against it, if a larger proportion of consumer income is spent on the commodity,
elasticity of demand is highly elastic.
8. Time Period: Price elasticity of demand for a commodity also affected by time period.
(a) Demand is inelastic in the short period as consumers find it difficult to change
their habits during short period.
(b) As against it, demand is highly elastic during long period as their is availability of close
substitutes in long period.
9. Habits
(a) The demand for those goods that are habitually consumed is inelastic. The reason is that
such commodities become a necessity for the consumer, and even if prices change,
consumers continue to purchase and consume the commodity. Examples of habit-forming
commodities include alcoholic beverages, tobacco (in its various forms) consumption and
even tea and coffee.
(b) As against it, if a person is not habitual, demand is elastic.
RECAP

1. Elasticity of Demand: The degree of responsiveness of demand to the changes in

determinants of demand (Price of the commodity, Income of a Consumer, Price of related
commodity) is known as elasticity of Demand.
2. Price elasticity of Demand: The degree of responsiveness of quantity demanded to
changes in price of commodity is known as price elasticity of Demand.
3. Percentage Method/Flux Method: According to this method, price elasticity of demand
is measured by dividing the percentage change in quantity demand by the percentage change
in price.

4. Unitary elastic demand: If percentage change in the quantity demanded is equal to

percentage change in price of the commodity, then ED = 1 and the result is known as unitary
elastic demand.
5. More than unitary elastic demand or elastic demand: If percentage change in quantity
demanded is more than the percentage change in price of the commodity then, ED > 1 and
result is known as more than unit elastic demand.
6. Less than unitary elastic demand or inelastic demand: If percentage change in quantity
demanded is less than the percentage change in price of the commodity, then ED < 1 and the
result is known as less than unit elastic demand.
7. Perfectly Elastic Demand: If quantity demand changes and price remains constant, then
ED = α and the result is known as perfectly elastic demand.
8. Perfectly Inelastic Demand: If price changes, and quantity demand remains constant,
then ED = 0 and the result is known as perfectly Inelastic Demand.
9. Total expenditure method: It indicates the direction in which total expenditure on a
product changes as a result of change in price of the commodity.
10. Geometric method or point method: According to point method, elasticity of demand at
any point is measured by dividing the lower segment of demand curve with the upper
segment of the demand curve at that point. It can be calculated by dividing the lower segment
by upper segment.
 BCom (P), Sem- V, Microeconomics
Ch-2

Unitary Elastic Demand (e=1):

When proportionate or percentage change in quantity demanded is exactly
equal to proportionate or percentage change in price, then demand is said
to be unitary elastic.
For instance, a 10% fall in price of a commodity leads to 10% rise in
demand of that commodity.
∴Ed=1
In this case, the demand curve slopes downwards uniformly.
This demand curve is called a rectangular hyperbola, as shown in the
figure.
The unity elasticity of demand is a dividing line to distinguish between
relatively elastic demand and relatively inelastic demand.