ELASTICITY

OF
DEMAND
Law of Demand
• Law of demand states that if price of commodity
increases quantity demanded will falls and if price
of commodity falls quantity will increases.

• Law of demand indicates only direction of change in

quantity demanded in response to change in price
but ELASTICITY OF DEMAND states with how much
or to what extent the quantity demanded will
change in response to change in price.
Elasticity- the concept
 If price rise by 10% - what happens to
demand?
 We know demand will fall
 By more than 10%?
 By less than 10 %?
 Elasticity measures the extent to which
demand will change
 Definition Of Price Elasticity Of Demand

• The change in the quantity demanded of a

product due to a change in its price is known
as Price elasticity of demand. Thus, the
sensitiveness or responsiveness of demand to
change in price is as called elasticity of
demand
 Kinds Of Price Elasticity Of Demand
1) Perfectly elastic demand
2) Relatively elastic demand
3) Elasticity of demand equal to utility
4) Relatively inelastic demand
5) Perfectly inelastic demand
Let Us See Some Views On Them
 Perfectly elastic demand

y
When the
Perfectly elastic
P demand curve demand for a
product changes
R
I
D
–increases or
D
C decreases even
when there is no
E change in price,
it is known as
perfect elastic
0 x
demand.
 Relatively elastic demand
y
When the
P Relatively elastic proportionate
demand curve
D
change in
R demand is more
I
than the
proportionate
C D
changes in
price, it is
E
0 x
known as
demand
relatively elastic
demand.
Elasticity of demand equal to utility

When the
y
D
proportionate
P
change in
demand is equal
R Elasticity of
demand equal to
I to utility proportionate
curve
D
changes in price,
C
it is known as
0 demand
x unitary elastic
E
demand
 Relatively inelastic demand
Y
D When the
Relatively inelastic
demand curve
proportionate
change in demand
P
is less than the
proportionate
R changes in price, it
I is known as
relatively inelastic
demand
C D

X
EO demand
Perfectly inelastic demand
Y
D
When a change in
price, howsover
Perfectly inelastic
P demand curve large, change no
changes in quality
demand, it is known
R
as perfectly
I inelastic demand

0 D X
demand
E
ALL KINDS OF DEMAND CAN BE SHOWN
IN ONE DIAGRAM AS FOLLOW
Y

WHERE
P D1) Perfectly elastic
R demand
D
I D1 D2)Relatively elastic
demand
D2 D3)Elasticity of demand
C D3
equal to utility
D4
D4)Relatively inelastic
E demand
0 D5 X
DEMAND D5)Perfectly inelastic
demand
Measurement Of Price Elasticity Of
Demand
There are main methods like
1. Percentage method or proportionate
method
2. Total outlay method or total revenue
method
3. Geometric method or point method
4. Arc elasticity of demand
1 Percentage method or proportionate method
(5) Factors Affecting Price Elasticity Of
Demand
 Factors Affecting Price Elasticity Of
Demand
• Nature of the Commodity
• Availability of Substitutes
• Variety of uses of commodity
• Postponement
• Influence of habits
• Proportion of Income spent on a commodity
• Range of prices
 Factors Affecting Price Elasticity Of
Demand
• Income Groups
• Elements of time
• Pattern of income distribution
(6) Practical Importance of the
Concept of Price Elasticity Of
Demand
Practical Importance of the Concept of
Price Elasticity Of Demand
• The concept is helpful in taking Business
Decisions
• Importance of the concept in formatting Tax
Policy of the government
• For determining the rewards of the Factors of
Production
• To determine the Terms of Trades Between
the Two Countries
Practical Importance of the Concept of
Price Elasticity Of Demand
• Determination of Rates of Foreign Exchange
• For Nationalization of Certain Industries
• In economic Analysis ,the concept of price
elasticity of demand helps in explaining the
irony of poverty in the midst of plenty.
(7) Income Elasticity Of Demand
Types Of Income Elasticity Of Demand

• Positive Income elasticity of demand

• Negative Income elasticity of demand
• Zero Income elasticity of demand
 Positive Income elasticity of demand
Y
D

A
Income

D
B
O X
Positive Income elasticity of demand

• Income Elasticity Equal to Unity or One

• Income Elasticity Greater Than Unity Or
One
• Income Elasticity Less Than Unity or
One
Negative Income elasticity of demand
Price

Total Revenue

Quantity Demanded (000s)

Zero Income elasticity of demand
Y
D
Income

O X
D

Quantity Demanded
 All Income Graphs Representation
Y
F
E
D
Income

C
B
A

O X
Quantity Demanded
 Measurement Of Income Elasticity Of
Demand

Proportionate change in Demand

Income Elasticity Of Demand =
Proportionate change in Income
i.e.
∆q ∆
Income Elasticity Of Demand = y +
Q Y
 Measurement Of Income Elasticity Of
Demand
• Here , ∆q = Change in the quantity demanded.
Q = Original quantity demanded.
∆y = Change in income.
Y = Original
income.
• For e.g. ,when Income of the consumer =
2,500/- , he purchases 20 units of X, when
income = 3,000/- he purchases 25 units of X
 Measurement Of Income Elasticity Of
Demand
• Thus
Income Elasticity of Demand
∆q ∆
= y +
Q Y

= (5/20) + (500/2500)
= 1.5
therefore here the IED is 1.5 which is more
than one.
Factors Affecting Income Of Demand
• Income Itself Only.
• Price Of the Commodity
 Importance Of the Concept of Income
Elasticity Of Demand
• In production planning and management
• In forecasting demand when change in
consumers income is expected
• In classifying goods as normal and
inferior
• In expansion and contraction of the firm by
the figure of income elasticity of demand
• Markets situations could be studied with the
help of IED
 (8) Elasticity Of Substitution
• The selection between two product or thing is
called substitution
• So Elasticity of Substitution measures the rate
at which the particular product is substituted .
• Thus EOS is the degree to which one product
could be substituted in context of price and
proportion
 Elasticity Of Substitution

• Elasticity of Substitution
= Proportionate change in the quantity ratios
of goods x & y DIVIDED BY Proportionate
change in the price ratios of goods x & y.
 Types of Elasticity Of Substitution
• Zero Elasticity of Substitution.
• Infinite Elasticity Of Substitution
• Elasticity of Substitution greater than unityor1
• Elasticity of Substitution is equal to one
• Elasticity of Substitution is less than one
Types of Elasticity Of Substitution on
Graph
Change in QUANTITIY ratio of good x & y
Y
E4
E3

E5

E2

E1
O X
Change in PRICE ratio of good x & y
 Relationship Between Price Elasticity,
Income Elasticity and Substitution
Elasticity
• As Price is depended on income and
substitution effect similarly Price Elasticity is
depended on Income Elasticity an Substitution
Elasticity .
• These relationship can be represented by
• Ep = Kx E1 + ( 1 – Kx ) es
 Price elasticity of demand depends on:

• Proportion of income spent on particular good

say X.
• Income elasticity of demand.
• Elasticity of substitution.
• Proportion of income spent on product other
than X.
 Cross Elasticity of Demand

• Cross elasticity of demand express a

relationship between the change in the
demand for a given product in response to a
change in the price of some other product
• E.g. if the X tea demand reduces
tremendously than it effect could be seen in
demand of sugar and milk.
 Types of Cross Elasticity of Demand

• Cross Elasticity of Demand Equal to Unity or

One
• Cross Elasticity of Demand Greater than Unity
or one
• Cross Elasticity of demand less than unity or
one
 Measurement Cross Elasticity of
Demand
Proportionate change in Demand
for product X
Cross Elasticity of Demand =
Proportionate change in Price of
i.e. product Y

Cross Elasticity of Demand = ∆qx +

∆p y
Qx Py
 Cross Elasticity of Demand For
Y Substitutes
D
Price of Y

O X
Demand for Y
 Cross Elasticity of Demand For
Y Complementary Products
D
Price of Y

D
O X
Demand for Y
Cross Elasticity of Demand For Neutral
Y Products
D
Price of Y

O X
Demand for Y
 Importance of Cross Elasticity Of
Demand
• The concept is of very great importance in
changing the price of the products having
substitutes and complementary goods .
• In demand forecasting
• Helps in measuring interdependence of price
of commodity .
• Multiproduct firms use these concept to
measure the effect of change in price of one
product on the demand of their other product
 Advertising Elasticity of Demand

• Advertising elasticity of demand is the

measure of the rate of change in demand
due to change in advertising expenditure
• The amount of change in demand of goods
due to advertisement is known as
Advertisement Elasticity of Demand .
 Advertising Elasticity of Demand

Proportionate change in Demand

for product
Advertising Elasticity of Demand =
Proportionate change in Advertising
i.e. expenditure

∆qx ∆a
Advertising Elasticity of Demand = ÷
Q A
 Relationship Between Advertising
Y
Expenditure and Sales
S
Sales

O X
Advertising Expenditure
Factors Affecting Advertising Elasticity
Of Demand
• The stage of the Product’s Market
Development .
• Reaction of market Rival Firms.
• Cumulative Effect of Past
Advertisement.
• Influence of Other Factors.
 Importance of the Advertising
Elasticity Of Demand in Business
Decisions
• It is useful in competitive industries.
• Though advertisement shifts the demand
curve to right path but it also increases the
fixed cost of the firm.
 Limitation of Advertising Elasticity of
the Demand
• The impact of advertising on sales is different
under different conditions, even if other
demand determinants are constant.
• Like wise, it is difficult to establish any co-
relationship between advertising expenditure
and volume of sales when there counter
advertisements by rival firm in the market .
The effect on sales depend on what the rivals
are doing.
Thanking You All
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