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Analysis of Demand: Dr. Syed Azhar

The document discusses the concept of elasticity of demand. It defines different types of elasticity including price elasticity, income elasticity, and cross elasticity. Price elasticity measures the responsiveness of demand to changes in price. Demand can be elastic, unit elastic, or inelastic depending on the magnitude of change in quantity demanded relative to a change in price. The document also discusses factors that influence price elasticity and provides examples to illustrate income elasticity. It explains the effects of price ceilings and price floors and how they can create surpluses or shortages without shifting the demand or supply curves. The importance of understanding elasticity for traders, monopolists, finance ministers, and international trade is noted.

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42 views

Analysis of Demand: Dr. Syed Azhar

The document discusses the concept of elasticity of demand. It defines different types of elasticity including price elasticity, income elasticity, and cross elasticity. Price elasticity measures the responsiveness of demand to changes in price. Demand can be elastic, unit elastic, or inelastic depending on the magnitude of change in quantity demanded relative to a change in price. The document also discusses factors that influence price elasticity and provides examples to illustrate income elasticity. It explains the effects of price ceilings and price floors and how they can create surpluses or shortages without shifting the demand or supply curves. The importance of understanding elasticity for traders, monopolists, finance ministers, and international trade is noted.

Uploaded by

Dr S Neelima
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© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Analysis of Demand

Dr. Syed Azhar


Elasticity of demand
• In previous session, we have examine the theory of demand.

• Other things being constant, when price falls, the quantity demanded
increases and vice-versa.

• Law of demand, explains the direction of change in the quantity demanded


but not the magnitude of change.

• The elasticity of demand explains the magnitude of change in price in


relation to quantity.
Types of Elasticity
• The price of the commodity in question, the income of the consumer,
the prices of substitutes and complementary goods bring about a
change in demand of that commodity.
• These variables are independent and demand is a dependent
variable.

1. Price elasticity of Demand


2. Income elasticity of Demand
3. Cross elasticity of demand
Price Elasticity
• The extent of responsiveness of demand with change in the price is
not always the same.

• The demand for a product can be elastic or inelastic, depending on


the rate of change in the demand with respect to change in price of a
product.

• Elastic demand is the one when the response of demand is greater


with a small proportionate change in the price. On the other hand,
inelastic demand is the one when there is relatively a less change in
the demand with a greater change in the price.

• The change in demand for a given change in price may be different in


different commodities and for different people.
• Price elasticity of Demand = proportionate change in demand
proportionate change in price
• Ep = Price elasticity of demand
• Proportionate change in demand = change in demand/ initial demand
• Proportionate change in qty= change in qty/ initial qty

• Ep = Δ Q ÷ Δp
Q p

= Δq x p
Δp q
Example

• =-4/100 X20/1 = -0.8

• The negative sign are ignored.


• the coefficient of elasticity, range from zero to infinity.
Types of Price Elasticity of Demand
• Based on the numerical value, price elasticity of demand can be

1. Perfectly elastic or infinitely elastic Ep= ∞


2. Relatively elastic Ep= <1
3. Unit Elasticity Ep =1
4. Relatively inelastic Ep=>1
5. Perfectly Inelastic or Zero inelastic Ep=0
Relatively inelastic demand
• When even a substantial change in price brings only a small
extension/contraction in demand, it is said to be less elastic.
• A fall of NN’ in price extends demand by MM’ only, which is very
small.
Determinants of price of Demand
• Nature of Commodity:
• Luxury goods – elastic, (eg: bs4 two wheelers)
• necessity goods- inelastic (eg: food items, clothes)

• Existence of Substitutes:
• If there are many substitutes for a commodity, the demand of the commodity is
elastic, and if there are very few substitutes for a commodity, the demand is
inelastic.

• Number of uses of the commodity:


• commodity many uses, the demand is elastic. Eg –coal electricity

• Possibility if postponement:
• purchase can be postponed, the demand Is elastic
Cont..
• Time element:
• in short run, demand will be more and long run it will be more.

• Complementary goods:
• In case of such goods, elasticity of demand is less elastic or inelastic

• Level of price:
• At higher level of price, demand is more elastic

• Proportion of total expenditure:


• If a consumer spends a larger proportion of his income on a particular good, price
elasticity of demand will be more for such good.
• For small change in price, the response in demand will be more.
• Conversely, the demand for commodites such as salt, match box absorb only a smaller
portion of consumer income, their demand will be inelastic.
Advertisement Elasticity of Demand
• It measures the expansion of demand through advertisement and other
promotional strategies. It is also known as advertisement elasticity of
demand. It may be expressed as: -
• EXA = percentage change in Dx/percentage change in A
Or
• EXA = DX X A
A Dx
Where A=expenditure on advertisement and promotional cost

• The advertisement elasticity is always positive. This is because both


informative and persuasive types of advertisements are used which
increase sales. The higher the elasticity, the better it is for the firm to spend
on promotional activities. This elasticity helps a decision maker to decide
upon the firm’s advertisement outlay.
Income Elasticity of Demand
• Income elasticity of demand is the degree of responsiveness of
quantity demanded of a commodity due to change in consumer’s
income, other things remaining constant. In other words, it measures
by how much the quantity demanded changes with respect to the
change in income.

• The income elasticity of demand is defined as the percentage change


in quantity demanded due to certain percent change in consumer’s
income.
Example to Explain Income Elasticity of Demand
Expression of Income Elasticity of
Suppose that the initial income of a person is
Rs.2000 and quantity demanded for the Demand
commodity by him is 20 units. When his income
increases to Rs.3000, quantity demanded by him Where, EY = Elasticity of demand
also increases to 40 units. Find out the income q = Original quantity demanded
elasticity of demand. ∆q = Change in quantity demanded
Solution:
Here, q = 100 units
∆q = (40-20) units = 20 units
y = Rs.2000
∆y =Rs. (3000-2000) =Rs.1000
Now,

Hence, an increase of Rs.1000 in income


i.e. 1% in income leads to a rise of 2% in quantity
demanded.
Price ceilings and price floors
Price ceilings
• Price ceilings prevent a price from rising above a certain level.
• When a price ceiling is set below the equilibrium price, quantity demanded
will exceed quantity supplied, and excess demand or shortages will result.

Price floors
• Price floors prevent a price from falling below a certain level.
• When a price floor is set above the equilibrium price, quantity supplied will
exceed quantity demanded, and excess supply or surpluses will result.
• When government laws regulate prices instead of letting market forces
determine prices, it is known as price control.
Price ceilings
• Laws enacted by the government to regulate prices are called price
controls. Price controls come in two flavors. A price ceiling keeps a price
from rising above a certain level—the “ceiling”. A price floor keeps a price
from falling below a certain level—the “floor”.
• We can use the demand and supply framework to understand price
ceilings.
• In many markets for goods and services, demanders outnumber suppliers.
Consumers, who are also potential voters, sometimes unite to convince the
government to hold down a certain price.
• For example, when rents begin to rise rapidly in a city—perhaps due to
rising incomes or a change in tastes—renters may press political leaders to
pass rent control laws, a price ceiling that usually works by stating that
rents can be raised by only a certain maximum percentage each year.
Price floors
• A price floor is the lowest legal price that can be paid in a market for goods and services,
labor, or financial capital. Perhaps the best-known example of a price floor is the
minimum wage, which is based on the normative view that someone working full time
ought to be able to afford a basic standard of living. The federal minimum wage at the
end of 2014 was $7.25 per hour, which yields an income for a single person slightly
higher than the poverty line. As the cost of living rises over time, Congress periodically
raises the federal minimum wage.

• Price floors are sometimes called price supports because they support a price by
preventing it from falling below a certain level. Around the world, many countries have
passed laws to create agricultural price supports. Farm prices, and thus farm incomes,
fluctuate—sometimes widely. So even if, on average, farm incomes are adequate, some
years they can be quite low. The purpose of price supports is to prevent these swings.
Do price ceilings and floors change demand or
supply?
• Neither price ceilings nor price floors cause demand or supply to
change. They simply set a price that limits what can be legally charged
in the market.

• Remember, changes in price do not cause demand or supply to


change. Price ceilings and price floors can cause a different choice of
quantity demanded along a demand curve, but they do not move the
demand curve. Price controls can cause a different choice of quantity
supplied along a supply curve, but they do not shift the supply curve.
Importance of Elasticity of Demand
• To the trader
• To the monopolist
• To the finance minister
• To the international trade

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