Price Elasticity of Demand in detail.pdf

Price Elasticity of Demand in detail

1. Elasticity of Demand

2. Elasticity of demand is defined as the responsiveness of the quantity
demanded of a good to changes in one of the variables on which
demand depends.
Elasticity of demand is the percentage change in quantity demanded
divided by the percentage change in one of the variables on which
demand depends.

3. Price Elasticity of Demand
Price elasticity of demand expresses the responsiveness of quantity demanded of a good
to a change in its price, given the consumer’s income, his tastes and prices of all other
goods.
In other words, it is measured as the percentage change in quantity demanded divided
by the percentage change in price, other things remaining equal.
The price elasticity of demand (PED) tells us the percentage change in quantity
demanded for each one percent (1%) change in price.

4. Price Elasticity of Demand

5. Price Elasticity of Demand

7. Income Elasticity of Demand
The income elasticity of demand is a measure of how much the demand
for a good is affected by changes in consumers’ incomes.
Estimates of income elasticity of demand are useful for businesses to
predict the possible growth in sales as the average incomes of consumers
grow over time.
Income elasticity of demand is the degree of responsiveness of the
quantity demanded of a good to changes in the income of consumers.

8. Income Elasticity of Demand

10. Solution:

11. CROSS -PRICE ELASTICITY OF DEMAND
The cross-price elasticity of demand between two goods measures the
effect of the change in one good’s price on the quantity demanded of the
other good. Here, we consider the effect of changes in relative prices
within a market on the pattern of demand.
A change in the demand for one good in response to a change in the
price of another good represents cross elasticity of demand of the former
good for the latter good.
It is equal to the percentage change in the quantity demanded of one
good divided by the percentage change in the other good’s price.

12. CROSS -PRICE ELASTICITY OF DEMAND

14. Five coefficients of price elasticity of
demand
Perfectly Inelastic Demand (eD= 0)
When the demand of a commodity
does not change as a result of
change in its price, the demand is
said to be perfectly inelastic. The
perfectly inelastic demand curve is
a vertical line parallel to y-axis as
shown in Fig. 4.2. As it is clear from
the diagram, price may be OP or
OP1 or OP2, but the demand will be
constant at OQ. In other words,
there is no effect of changes in the
price on the quantity demanded. It
exists in case of essentials like life
saving drugs.

15. Inelastic (or less than unit elastic) Demand
(0 < eD< 1)
When a change in price leads to
a less than proportionate change
in the demand, the demand is
said to be less elastic or inelastic.
It is shown in fig. where price falls
by ` 8, quantity demanded
increases by only 1 unit. The
coefficient of price elasticity of
demand is said to be less than 1
unit. The slope of an inelastic
demand curve is more, i.e., the
demand curve is steep as shown
in Fig.Itexists in case of necessities
like food, fuel, etc.

16. Unit Elastic Demand (eD= 1)
When percentage change in demand is
equal to the percentage change in
price, the demand for the commodity is
said to be unitary elastic.
It is shown in Table , where when price
falls by ` 5, demand increases by 10
units. The unitary elastic demand curve is
a straight downward sloping line forming
45°angles with both the axis. It is also a
rectangular hyperbola. It is drawn in Fig.
It exists in case of normal goods.The
unitary elastic demand curve shows that
when price falls from OP to OP
1,
demand rises from OQ to OQ
1. The
change in demand (QQ
1) is equal to the
change in price (PP
1).

17. Elastic (or more than unit elastic) Demand (1
< eD< ¥)

18. The elastic demand curve shows that when price falls from OP to OP
1,
demand rises from
OQ to OQ
1. The change in demand (QQ
1) is more than the change in price
(PP
1).

19. Perfectly Elastic Demand (eD= ¥)
Perfectlyelasticdemand
curveisahorizontalline
paralleltothex-axis.It
meansthatatpriceOP,
quantitydemandedcan
beOQorOQ
1orOQ
2.

21. FACTORS AFFECTING PRICE ELASTICITY OF DEMAND
The factors which determine the price elasticity of demand for a commodity or
service are:
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.
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, the elasticity of
demand is high.

22. Luxuries versus Necessities. The price elasticity of demand is likely to be low
for necessities and high for luxuries. 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. Example: eating in a 5-Star
hotel. If the price of necessities rise, then demand will not fall by a greater
proportion because their purchase cannot be delayed. That is why, the
price elasticity of demand in case of necessity is low.
Proportion of Total Expenditure Spent on the Product. Higher the cost of the
good relative to total income of the consumer, more will be the price
elasticity of demand. If the price of bread, ink, salt, match box, etc., which
is relatively low, doubles it would have almost no effect on the quantity
demanded of them. On the other hand, if price of car doubles then the
quantity demanded will fall by a greater proportion showing high price
elasticity of demand.

23. Number of Uses of the Commodity. The more the number of uses a
commodity can be put to, the more elastic is the demand. If a commodity
has few uses, it has an inelastic demand. Examples: goods like milk, eggs
and electricity can be put to many different uses and hence, enjoy elastic
demand, i.e., when prices are low, demand increases by a greater
proportion as the goods can now be put to less important uses also.
Time Period. If the time period needed to find substitutes of the commodity
is more, the price elasticity of demand is more and vice versa. Example:
flying by airplane has inelastic demand as no substitutes are available in
the short run.