Factors affecting Demand

Income
Awareness about environment
Government Policy
No. of players in market
Life Style
Consumtion of Energy

Factors affecting Supply

Price of Lithum batteries
Localization of inputs to bring down the cost
Economies of scale
No. of players in market/Volume
Economies of scale
Substitutes

Sunday, January 1
23, 2022
 ELASTICITY OF
DEMAND
Anshuman Sinha

Sunday, January 23, 20 2

Do People Respond to Changes in the Price of Gasoline?
Some argue that people don’t vary the quantity of /petrol they buy as the price changes.

Do you think this is correct?

From September 2011 to September 2012, the price of gasoline rose by about 7% ($3.66 per gallon
to $3.91 per gallon).
• Gasoline consumption fell by about 5%.

People do respond to incentives, changing their behavior as prices, incomes, and prices of related
goods change

© Pearson Education Limited 2015 3 of 58

Elasticity: The Responsiveness of Demand and Supply

Elasticity A measure of how

much one economic variable
responds to changes in another
economic variable.
Price Elasticity of Demand
■ Definition

The responsiveness of the quantity demanded to a change

in price, measured by dividing the percentage change in
the quantity demanded of a product by the percentage
change in the product’s price.

Sunday, January 6
Sunday, January 7
23, 2022
Methods of Measuring Elasticity

■ Percentage Method
■ Arc Elasticity Method
■ Point Elasticity

Sunday, January 8
■ Percentage Method:

% Change in quantity demanded

% Change in the own price

Q / Q Q P
EP   
P / P P Q
Sunday, January 9
 Examples: Percentage Method
■ 1. Renu used to consume 10 ice creams a month when the price
of an ice-cream was Rs. 12. Ice-cream has become more
expensive with Rs 15 a piece. Renu now consumes 8 ice-creams
a month. What is the Price elasticity of demand for ice-cream
by Renu?
■ 2. Yesterday, the price of envelopes was $3 a box, and Alka was
willing to buy 10 boxes. Today, the price has gone up to $3.75
a box, and Alka is now willing to buy 8 boxes. Is Alka's
demand for envelopes elastic or inelastic? What is Alka's
elasticity of demand?

Sunday, January 10
Answer:

■ .80
■ % Change in Quantity = (8 - 10)/(10) = -0.20 = -20% 
% Change in Price = (3.75 - 3.00)/(3.00) = 0.25 = 25% 
Elasticity = |(-20%)/(25%)| = |-0.8| = 0.8 

Her elasticity of demand is 0.8. Elasticity of demand is

inelastic, since it is less than 1.

Sunday, January 11
 Q2  Q1 P2  P1
Arc Definition EP  
P2  P1 Q2  Q1

Sunday, January 12
Example: Arc Method
■ The accompanying table shows the price and yearly quantity sold of T-shirts in the town
of Crystal Lake according to the average income of the tourists visiting. Using the arc
elasticity method, calculate the price elasticity of demand when the price of a T-shirt
rises from $5 to $6 and the average tourist income is $20,000. Also calculate it when the
average tourist income is $30,000.
Price of T-shirt Quantity of T-shirts Quantity of T-shirts
demanded when the demanded when the
average tourist income is average tourist income is
$20,000 $30,000
$4 3,000 5,000
$5 2,400 4,200
$6 1,600 3,000
$7 800 1,800

Sunday, January 13
Example: Arc Method
■ The accompanying table shows the price and yearly quantity sold of T-shirts in the town
of Crystal Lake according to the average income of the tourists visiting. Using the arc
elasticity method, calculate the price elasticity of demand when the price of a T-shirt
rises from $5 to $6 and the average tourist income is $20,000. Also calculate it when the
average tourist income is $30,000.

Price of T-shirt Quantity of T-shirts Quantity of T-shirts

demanded when the demanded when the
average tourist income is average tourist income is
$20,000 $30,000
$4 3,000 5,000
$5 2,400 4,200
$6 1,600 3,000
$7 800 1,800
ANSWER: 2.2 and 1.8

Sunday, January 14
 P
Point Elasticity EP  a1 
Q
(Linear Function)

Sunday, January 15
 Example –Point Method

■ Q = 2400 – 100 P. Calculate Ep when Price is Rs. 9 and Qd =

1500
■ Q = 10 – 20 P. Calculate Ep when Price is Rs. 40 and Qd = 400

Sunday, January 16
Example –Point Method

■ Q = 2400 – 100 P. Calculate Ep when Price is Rs. 9 and Qd = 1500

Ep = -100* 9/1500
= |-0.6| = 0.6

■ Q = 10 – 20 P. Calculate Ep when Price is Rs. 40 and Qd = 400

Ep = -20* 40/400
=|-2| = 2

Sunday, January 17
Degrees of Elasticity
■ If Ep greater than 1 we say that product demand is
relatively elastic.
■ If Ep less than 1 we say that product demand is
relatively inelastic.
■ Ep=1(unit elastic)
■ Ep=0 (perfectly inelastic)
■ Ep= infinite (perfectly elastic)

Sunday, January 18
 Determinants of Price Elasticity of
Demand
■ Nature of Commodity
■ Availability and Proximity of Substitutes
■ Alternative uses of the commodity
■ Proportion of income spent on the commodity
■ Time (Demand for any commodity is usually more price elastic in the long
run. The reason is simple, consumers take time to adjust their consumption
pattern to accommodate substitutes in their consumption bundles. A shift
from petrol driven automobiles to CNG driven is a typical example. It may
not be feasible for consumers to switch from petrol driven cars in the short
run, but they would gradually shift to CNG in the long run.)
■ Items of addiction
Sunday, January 19
What Determines the Price Elasticity of Demand?
■Why do some goods have a high price elasticity of demand, while others
have a low price elasticity of demand?

■There are several characteristics of the good, of the market, etc. that
determine this.

1. The availability of close substitutes

■If a product has more substitutes available, it will have more elastic
demand.
■Example: There are few substitutes for gasoline, so its price elasticity of
demand is low.
■Example: There are many substitutes for Nikes (Reeboks, Adidas, etc.), so
their price elasticity of demand is high.

© Pearson Education Limited 2015 20 of 58

More Determinants of the Price Elasticity of Demand

2. The passage of time

■Over time, people can adjust their buying habits more easily. Elasticity is
higher in the long run than the short run.
■Example: If the price of gasoline rises, it takes a while for people to adjust
their gasoline consumption. How might they do that?
• Buying a more fuel-efficient car
• Moving closer to work

3. Whether the good is a luxury or a necessity

■People are more flexible with luxuries than necessities, so price elasticity of
demand is higher for luxuries.
■Example: Many people consider milk and bread necessities; they will buy
them every week almost regardless of the price.
■And if the price goes down, they won’t drastically increase their
consumption of bread or milk.
© Pearson Education Limited 2015 21 of 58
Yet More Determinants of the Price Elasticity of Demand

4. The definition of the market

■The more narrowly defined the market, the more substitutes are available,
and hence the more elastic is demand.
■Example: You might believe there is no good substitute for jeans, so your
demand for jeans is very inelastic.
■But if you consider different brands of jeans, you might be more sensitive to
the price of a particular brand.

5. The share of a good in a consumer’s budget

■If a good is a small portion of your budget, you will likely not be very
sensitive to its price.
■Example: You might buy table salt once a year or less; changes in its price
will not affect very much how much you buy.
■Example: Changes in the price of housing do affect where people choose to
live.

© Pearson Education Limited 2015 22 of 58

Some Real-World Price Elasticities of Demand
Estimated Estimated
Product Elasticity Product Elasticity
Books (Barnes & Noble) –4.00 Bread –0.40
Books (Amazon) –0.60 Water (residential use) –0.38
DVDs (Amazon) –3.10 Chicken –0.37

Post Raisin Bran –2.50 Cocaine –0.28

Automobiles –1.95 Cigarettes –0.25

Tide (liquid detergent) –3.92 Beer –0.29

Coca-Cola –1.22 Catholic school attendance –0.19
Grapes –1.18 Residential natural gas –0.09

Restaurant meals –0.67 Gasoline –0.06

Health insurance (low-income

–0.65 Milk –0.04
households)

Sugar –0.04

■Estimated real-world price

elasticities of demand

© Pearson Education Limited 2015 23 of 58

 Situation 1
■ What do you think the price elasticity of demand for Ford sport-utility
vehicles (SUVs) will increase, decrease, or remain the same when each of
the following events occurs? Explain your answer.
■ a. Other car manufacturers, such as General Motors, decide to make and
sell SUVs. Increase

■ b. SUVs produced in foreign countries are banned in the Indian

market. Decrease
■ c. Due to ad campaigns, Indians believe that SUVs are much safer
than ordinary passenger cars. Decrease
■ d. The time period over which you measure the elasticity lengthens.
During that longer time, new models such as four-wheel-drive cargo
vans appear. Increase
Sunday, January 24
■ a. The price elasticity of demand for Ford SUVs will increase because more
substitutes are available.
■ b. The price elasticity of demand for Ford SUVs will decrease because fewer
substitutes are available.
■ c. The price elasticity of demand for Ford SUVs will decrease because other
cars are viewed as less of a substitute.
■ d. The price elasticity of demand for Ford SUVs will increase over time because
more substitutes (such as four-wheel-drive cargo vans) become available.

Sunday, January 25
 Situation 2

■ What can you conclude about the price elasticity of demand in each of the
following statements?

■ a. “The pizza delivery business in this town is very competitive. I’d lose
half my customers if I raised the price by as little as 10%.”
■ b. “My economics professor has chosen to use the Thomas & Maurice
textbook for this class. I have no choice but to buy this book.”

Sunday, January 26
Answer to Question:

■ a. This statement says that a 10% increase in price

reduces the quantity demanded by 50%. That is, the
price elasticity of demand is -50%/10% = 5 . So
demand is elastic.
■ b. Demand is inelastic.

Sunday, January 27
Situation 3

■ Which of the following goods are likely to have elastic

demand, and which are likely to have inelastic demand? 
 
a. Pepsi 
b. Chocolate 
c. Water 
d. Heart medication 
 

Sunday, January 28
Answer

■ Elastic demand: Pepsi, chocolate. 

Inelastic demand: water, and heart medication

Sunday, January 29
Assignment

■ If Neil's elasticity of demand for toffees is

constantly 0.9, and he buys 4 toffees when the
price is Rs. 1.50 per toffee, how many will he
buy when the price is Rs. 1.00 per toffee?

Sunday, January 30
Assignment

■ Katherine advertises to sell cookies for $4 a dozen.

She sells 50 dozen, and decides that she can charge
more. She raises the price to $6 a dozen and sells 40
dozen. What is the elasticity of demand? Assuming
that the elasticity of demand is constant, how many
would she sell if the price were $10 a box?

Sunday, January 31
■ % Change in Quantity = (40 - 50)/(50) = -0.20 =
-20% 
% Change in Price = (6.00 - 4.00)/(4.00) = 0.50 =
50% 
Elasticity = |(-20%)/(50%)| = |-0.4| = 0.4 

The elasticity of demand is 0.4 (elastic). 

The new demand at $10 a dozen will be 20 dozen

cookies.
Sunday, January 32
 Be Inelastic to your Values

HUMAN VALUES SHOULD PREDOMINATE IN MEN’S THOUGHTS

Human life has no meaning without these values
 
Try not to become a man of success but a man of value (Albert Einstein)

Sunday, January 34
 Income Elasticity of Demand (IED)

Cross-price Elasticity of Demand (CED)

Advertisement Elasticity of Demand (AED)

IED: Concept

■ Income elasticity of demand (IED)

measures the responsiveness of quantity
demanded to changes in consumer
income, holding the price of the good &
all other factors constant
Income Elasticity

■ As income increase,
– items that have an income elastic demand
take an increasing share of income
– Items that have an income elastic demand
take a decreasing share of income
– Items that have a negative income
elasticity of demand take an absolutely
smaller amount of income
IED: Types/Degrees

■ IED < 0 [Inferior good]

■ IED = 0 [Sticky good]

■ IED > 0 [Normal good]

– IED ≤ 1 [Necessity good]

– IED > 1 [Luxury good]

IED: Calculation Methods
• Point method used for calculating IED
• At a given income

• Arc method used for calculating IED

• Over an interval/range of income
Good-Bad-Neuter

Good: a commodity which provides utility

Bad: a commodity which provides

disutility

Neuter: a commodity which provides

neither utility nor disutility
IED: Business Implications

■ During periods of expansion, incomes are

rising, and firms selling luxury items will
find that the demand for their products
will increase at a rate that is faster than
the rate of income growth. However,
during a recession (economic slow
down), demand decreases rapidly.
IED: Business Implications

■ Conversely, sellers of necessities will not

benefit as much during periods of
economic prosperity, but will also find
that their markets are somewhat
recession-proof. That is, the change in
demand will be less than that in the
economy in general.
Summary of Income Elasticity of Demand
If the income elasticity
of demand is… then the good is… Example

positive but less than 1 normal and a necessity Bread

Caviar/Safr
positive and greater than 1 normal and a luxury
on
Old fashion
negative inferior
clothes

■Necessity: A normal good with a quantity ■Summary of income elasticity

demanded that responds less than of demand

proportionally to a price change.

■Luxury: A normal good with a quantity

demanded that responds more than
proportionally to a price change.

© Pearson Education Limited 2015 43 of 58

CED: Concept
•  
■ Domino’s Pizza has a BIG problem! KFC
just cut its prices. Ram, the manager of
Domino’s, knows that pizzas and burgers
are substitutes. He also knows that when
the price of a substitute for pizza falls, the
demand for pizza decreases.
■ How much will the quantity of pizza bought
decrease if Ram maintains his current
price?
■ Also, pizza and cold drink are complements. He
knows that if the price of a complement of pizza
falls, the demand for pizza increases. So could he
keep his customers by cutting the price he charges
for cold drink? But how much must he cut the
price of cold drink to keep selling the same quantity
of pizza with cheaper burgers at KFC?
 CED: Types/Degrees

■CED > 0 [Substitutes in consumption]

Substitute goods: goods that can replace each other; when the price of good
X rises, the demand for good Y increases, and vice versa, ceteris paribus.
CED < 0 [Complements in consumption]
Complementary goods: goods frequently consumed in combination; when
the price of good X rises, the demand for good Y decreases, and vice versa,
ceteris paribus.
 CED: Calculation Methods
• Point method used for calculating CED
• At a particular price of related good (say Y)

• Arc method used for calculating CED

• Over an interval/range of price of related good (say Y)
– If popcorn sales declined 20% when the movie
admission price increased 10%, the cross-price
elasticity of popcorn is -2.0, a relatively elastic
response.
– Again the sign is significant. When goods are
complements, cross-price elasticity is negative.
CED: Business Implications
■ CED between products of competitors is
positive
– If the competitor of a firm reduces the
price of product, the firm has to reduce
price to avoid losing sales
– If the competitor of a firm raises the price
of product, the firm can raise or maintain
the same price
CED: Business Implications

■ CED between complementary products

is negative
– Increase in price of a product will reduce
the demand for its complementary products
(e.g., increase in car price will reduce the
demand for tyre, car insurance, etc)
Summary of the Cross-Price Elasticity of Demand

then the cross-

If the price elasticity of
products are… demand will be… Example
substitutes positive Two brands of tablet
computers
complements negative Tablet computers and
applications downloaded from
online stores
unrelated zero Tablet computers and peanut
butter

■Summary of cross-price elasticity of

demand

© Pearson Education Limited 2015 52 of 58

 Making
the Elasticities of Alcoholic Beverages
Connection
Christopher Ruhm of the University
of Virginia and colleagues estimated
elasticities for various alcoholic
beverages. According to their study:
Price elasticity of −0.30
demand for beer Demand for beer is price inelastic.
Cross-price elasticity of −0.83
demand between beer
and wine Beer and wine are complements.
Cross-price elasticity of −0.50
demand between beer Beer and spirits are also
and spirits
complements, but the relationship is
Income elasticity of 0.09 not as strong.
demand for beer

Beer is a normal good; a necessity.

Are any of these results surprising

to you? Why or why not?
© Pearson Education Limited 2015 53 of 58
■Price Elasticity, Cross-Price Elasticity, and Income Elasticity in the
Market for Alcoholic Beverages

Income elasticity of demand for beer -0.09

Income elasticity of demand for wine 5.03
Income elasticity of demand for spirits 1.21

An “Inferior/ Superior Good?”

 Making
the
Connection
■ https://www.youtube.com/watch?v=p2E1D8AVhUc
■ https://www.youtube.com/watch?v=rlMMtKa4kaE (Emotional attachment to brands means we're
prepared to pay more for them | Marketing Media Money)
■
https://www.cnbc.com/2017/12/08/virtual-reality-continues-to-grow--but-supply-of-workers-is-limited.
html

© Pearson Education Limited 2015 55 of 58

 Advertisement Elasticity of Demand (AED):
Concept

■ AED measures responsiveness of quantity demanded of a product to changes in the

advertisement expenditure on the product, other things remaining constant:

■ AED is generally positive