Eco Book Chapter-3

CH-03: ELASTICITY OF DEMAND AND SUPPLY
CHAPTER-03
“ELASTICITY OF DEMAND AND SUPPLY”

PART-01: ELASTICITY OF DEMAND
1.1: DEFINITION AND DEGREE OF ELASTICITY OF DEMAND 65

1.2: CALCULATION AND INTERPRETATION OF ELASTICITY OF DEMAND: 68
1.3: DETERMINANTS/FACTORS AFFECTING/INFLUENCING ELASTICITY OF DEMAND: 71
1.4: PRACTICAL IMPORTANCE / SIGNIFICANCE OF ELASTICITY OF DEMAND 72
PART-02: OTHER VARIANTS OF ELASTICITY OF DEMAND
2.1: INCOME ELASTICITY OF DEMAND (YED): 73

2.2: CROSS ELASTICITY OF DEMAND (XED): 74
PART-03: PRICE ELASTICITY OF SUPPLY
3.1: DEFINITION AND TYPES OF ELASTICITY OF SUPPLY: 75

3.2: DETERMINANTS/FACTORS AFFECTING ELASTICITY OF SUPPLY: 77
3.3: TIME AND ELASTICITY OF SUPPLY 78
PART-04: PRICE INSTABILITY AND ROLE OF GOVERNMENT
4.1: PRICE INSTABILITY: 79

4.2: COBWEB THEORY: 79
4.3: GOVERNMENT’S POLICIES TO INCREASE PRICE STABILITY: 81
PART-05: MULTIPLE CHOICE QUESTIONS & TEST-03
MCQ 82
TEST-03 92
PRC-03: PRINCIPLES OF ECONOMICS | 64

Elasticity:
Measure of the responsiveness of a change in one variable due to another variable.
Types: Price Elasticity of demand (PED)

Two types of Elasticities:
• Elasticity of Demand Income Elasticity of demand (YED)
• Elasticity of Supply
Cross Elasticity of demand (XED)
PART-01: ELASTICITY OF DEMAND
The law of demand states the relationship between price and quantity of demand for a certain good
but, it does not explain that how much of an increase or decrease in quantity demanded occurs due
to a change in price. The elasticity of demand explains the level of change in quantity demanded in
response to change in price.
1.1: DEFINITION AND DEGREE OF ELASTICITY OF DEMAND
Definition of Price Elasticity of Demand (η):

Degree of responsive of change in demand to the change in its price is called elasticity of demand.
OR
Price Elasticity of Demand is the ratio of the percentage change in quantity demanded to the
percentage change in price of a good.
percentage change in Quantity demanded % Δ Qd

PED (η) = = %ΔP
percentage change in Price
Estimation/Types of Elasticity of Demand:

There are mainly three types of elasticity of demand regarding a product. They are:
a) Price elasticity of demand:
Proportionate change in quantity demanded/Proportionate change in price
b) Income elasticity of demand:

Proportionate change in quantity demanded/Proportionate change in income.
c) Cross-elasticity of demand or elasticity of demand between related goods:

It is the proportionate change in quantity demanded for product A / proportionate change in
price of product B.

Degree of Elasticity of Demand:
Price
1) Perfectly Inelastic Demand:
• If quantity demanded does not change P1
with change in its price, it is called
Perfectly inelastic demand.
(Demand totally unaffected/unresponsive P0

by change in price)
• PED = 0 Demand curve (D)

• Slope of Demand curve is vertical, parallel
0 Q0
to y-axis
Quantity Demanded
2) Inelastic/Less elastic Demand: Price

• If percentage change in quantity
demanded is lesser than percentage P1
change in its price, it is called Inelastic
demand.
P0
• PED < 1.
• Slope of Demand curve is sharp/steeper

Demand curve (D)
0 Q1 Q0
Quantity Demanded
Price
3) Unit/Unitary Elastic Demand: P1

demanded is equal to percentage change
in its price, it is called Unit elastic demand
P0
• PED = 1.
Demand curve (D)
0 Q1 Q0
Quantity Demanded

4) Elastic Demand: Price

demanded is greater than percentage P1
change in its price, it is called elastic P0
demand
• PED > 1. Demand curve (D)
• Slope of Demand curve is

0 Q1 Q0
shallow/flatter.
Quantity Demanded
5) Perfectly Elastic Demand: Price

• A nominal (minuscule) change in price
will largely (infinitely) affect the demand
for the product., it is called Perfectly Demand curve (D)
elastic supply P0
• Slope of Demand curve is horizontal,

parallel to x-axis.
• PED = ∞ (infinite).
0 Q0 Q1
Quantity Demanded

1.2: METHODS TO MEASURE ELASTICITY OF DEMAND:
1. Percentage Method (Point Elasticity of Demand and Arc Elasticity of Demand).

2. Total Revenue or Total Expenditure or Total Outlay Method.
3. Geometric Method.
1) Percentage Method:
To get the accurate value of elasticity of demand we will use percentage method, which describes
the ratio between percentage change in quantity demanded to percentage change in its price.
% Δ Qd
PED (η) = 𝑃𝑒𝑟𝑐𝑒𝑛𝑡𝑎𝑔𝑒 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑞𝑢𝑎𝑛𝑡𝑖𝑡𝑦 𝑑𝑒𝑚𝑎𝑛𝑑=
𝑃𝑒𝑟𝑐𝑒𝑛𝑡𝑎𝑔𝑒 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑝𝑟𝑖𝑐𝑒 %ΔP
(i) Point method: Price
When elasticity of demand is to be measured for

P1
a very small change in price, such as in case of
P0
petroleum and electricity rate, we use point
elasticity of demand.
Formula:
𝑄1−𝑄0
D
% Δ Qd ×100
PED = = η = 𝑄0
%ΔP 𝑃1−𝑃0
×100 O Q0 Q1 Quantity Demanded
𝑃0
Example-01
The price of petrol decreases from Rs.12 to Rs.11.75. At the same time, the quantity of petrol
demanded increases from 100 to 101. The price elasticity of demand for petrol (by using point
formula) is:
Answer:
Price Quantity Demand
12 100
11.75 101
Change - 0.25 +1
𝑄1−𝑄0 101−100
% Δ Qd ×100 100
×100
PED = =η = 𝑄0 =
%ΔP 𝑃1−𝑃0 11.75−12
×100 ×100
𝑃0 12
PED = 1 = -0.48 (Ignoring the -ve sign, PED = 0.48) inelastic demand
2.083

(ii) Arc method:

Price
When elasticity of demand is to be measured for
a significant change in price, such as poultry,
dairy or case of crops etc., it is said to be arc P1 a
elasticity of demand.
b
In Arc elasticity, average of both points is P0
used as base to calculate percentage change. D
Formula:
% Δ Qd Δ Qd 𝑃(𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑝𝑟𝑖𝑐𝑒)
PED = = x
%ΔP ΔP Qd (Average quantity)
OR
O Q1 Q0 Quantity Demanded
Q1 − Q0 𝑃1 + 𝑃0
η = ×
Q1+ Q 0 𝑃 −
1 𝑃 0
Example-02: (Arc method)

Compute the price elasticity of a product if an increase in the price of the product from Rs. 8 per
unit to Rs. 12 per unit causes a decrease in its demand from 300
units to 100 units.
Answer:
Price Quantity Demand
8 300
12 100
Q1−Q0 𝑃1 +𝑃0
PED = η = ×
Q1+Q0 𝑃1−𝑃0
100−300 12+8
PED = η = × = -2.5 (Ignoring the -ve sign, PED = 2.5) Elastic demand
100+300 12−8
Interpretation of Price Elasticity of Demand:

• Elastic demand = sensitive to price changes
• Inelastic demand = insensitive to price changes
1) Sign Shows (Types of Good)
➢ If Answer is “Negative”, it is a normal good.
➢ If Answer is “Positive”, it is a giffen good.
2) Numeric value Shows (Elasticity of demand)

Absolute value of coefficient or Degree of Elasticity
numerical value of Elasticity
E=0 Perfectly Inelastic Demand
0<E<1 Relatively inelastic Demand
E=1 Unitary elastic Demand
E>1 Elastic Demand
E = ‘Infinity (∞)’ perfectly elastic Demand

2) Total Revenue/Total Expenditure/Total Outlay Method:

This method was first proposed by Alfred Marshal. In this method we compare the changes in total
expenditure/revenue before and after the changes in price.
The total expenditure method offers a simple solution to determine whether a good has Inelastic,
unitary or elastic demand without any Calculation.
• Elastic Demand:
If price and total revenue move in opposite direction (i.e. increase in price decreases total revenue.)
then demand will be elastic.
Price (P) Demand (Q) Total Revenue (TR = P X Q)
Price
D
10 15 150
15 6 90 Quantity Demanded
• Unit elastic Demand:

If total revenue does not change with the change in prices, then demand will be unit elastic.
Price
10 15 150
D
15 10 150 Quantity Demanded
• Inelastic Demand:
If price and total revenue move in same direction (i.e. increase in price increases total revenue) then
demand will be inelastic.
Price
10 15 150
D
15 14 210
Quantity Demanded
Relationship between Price elasticity of Demand and Revenue.
The effect of a price change on revenue depends on the elasticity of demand.

• If P.E.D. is elastic, a fall in price increases revenue.
• If P.E.D. is inelastic, a rise in price increases revenue.
• If P.E.D. is unitary, a price change leaves revenue unchanged

(3) Geometric Method: (Geometrical measure of point elasticity of demand)

Geometric method is used to measure elasticity of demand at any pint on the demand curve.
The formula to measure elasticity of demand is:
𝑙𝑜𝑤𝑒𝑟 𝑝𝑎𝑟𝑡 𝑜𝑓 𝑡ℎ𝑒 𝑑𝑒𝑚𝑎𝑛𝑑 𝑐𝑢𝑟𝑣𝑒
η=
𝑢𝑝𝑝𝑒𝑟 𝑝𝑎𝑟𝑡 𝑜𝑓 𝑡ℎ𝑒 𝑑𝑒𝑚𝑎𝑛𝑑 𝑐𝑢𝑟𝑣𝑒
1) Elasticity on a demand curve is different at different points. Demand is unit elastic at center,
from center to above, Demand is elastic and from center to lower Demand is inelastic
PED at point A = 𝐴𝐸 = Elastic (E > 1)

𝐴𝐹
Price F
A ( E ˃ 1) Elastic
B ( E = 1) Unit Elastic
C ( E ˂ 1) Inelastic
E
O Quantity Demanded
1.3: DETERMINANTS OF ELASTICITY OF DEMAND:
Determinants are those factors, which affect the degree of elasticity of demand. Such determinants
are very helpful while formulating economic business plans for both government and individuals.
1. Necessities or Luxuries:
• Demand for necessities is inelastic because people cannot avoid these goods, whatever the
price level. e.g. wheat, salt, milk, rice, medicines, sugar.
• Demand for luxuries or comfort good is relatively elastic as people can stay without using
the product shortly, e.g. branded car, iphone
2. The possibility of substitution:

• If there are close substitutes for a good, its demand is likely to be more elastic.
For example, a rise in the price of coffee will cause people to take more tea
• If there are no close substitutes within the same price range, the demand for a commodity is
more likely to be inelastic as people do not have any option to switch, e.g. electricity
3. The case of complementary goods:

• Complementary goods are those goods which are used together, e.g. car and petrol
If price of one good (Car) decrease, demand for its complement (petrol) increase, will make
demand inelastic.
• If price of one good (Car) increase, demand for its complement (petrol) decrease, will make
demand elastic

4. Habit of brand loyalty (Addiction):

• Demand will be inelastic, if consumers are loyal to their brand and unwilling to change their
demand even if price increases. e.g., Tobacco, TV-show, Hand wash, branded car, cloths, i-
phone
• If there is no consumer loyalty, demand will be elastic.
5. Time Period:
• In short time (in case emergency) demand will be inelastic (e.g. to buy lifesaving medicines)
because we cannot postpone such demand.
• The longer the time-period involved, the greater the elasticity of demand is likely to be. This
is because it takes time to adjust to a change in price. (e.g. to buy House or Car)
6. Proportion of income spent for a product:

The smaller the proportion of total income spent on a commodity, the more inelastic will be
demand for it. For example, a rise in the price of tomato ketchup will not stop people buying
it, because it is less frequently purchased, and it does not account for a great deal of a
person’s total expenditure. e.g Salt, tomato ketchup and match box.
1.4: APPLICATION OR IMPORTANCE OF ELASTICITY OF DEMAND
The importance of elasticity of demand can be viewed from the following:
For Finance Minister (taxation)

• The concept of elasticity of demand guides him to impose more taxes on goods, having
inelastic demand i.e., tobacco, electricity, luxury cars and apartments to increase Tax revenue.
• However, if they tax a good with elastic demand, this may cause demand to decrease to a great
extent and tax revenue will be less than before
Price determination
Producer can charge higher prices for those goods having inelastic demand and lower price
having elastic demand.
Guidance for monopolists:

• In the case of inelastic goods, price will be higher and it will be sold in a smaller quantity as
the monopolists know that the consumer will buy the product at any price as demand is
inelastic.
• In case of market demand for elastic goods, price will be kept low intentionally to retain the
maximum buyers with the product and demand for the good is stimulated through some
other activities such as promos, exhibitions, or advertisement etc.
Determination of fares:
• Fares of road transportations, such as buses, taxis etc. is low due to elastic demand because
if price on transport were increased there would be some substitute, like, railways, uber, etc.
• However, for inelastic transport, such as airways, the fare is quite high as there is no other
alternative for a person to get to one place form another as quickly as by air.

For Balance of Trade and Payments:

Exporters are charging high prices for goods having inelastic demand and lower price for
goods having elastic demand. If demand of an export-product is inelastic, an increase in price
will improve “Balance of Payment” of country.
Decision making during economic recessions:

Elasticity helps firms to predict, that which product with what intensity will hit during
recession, when the income shrinks. Accordingly, firm can change their decision to avoid their
losses.
PART-02: OTHERS ELASTICITIES OF DEMAND:
2.1: INCOME ELASTICITY OF DEMAND:
Definition:
Income elasticity of demand is the measure of the responsiveness of demand to a change in
consumer’s income.
OR
Income Elasticity of Demand is the ratio of the percentage change in quantity demanded to the
percentage change in income.
% Δ Qd
YED = percentage change in Quantity demanded =
percentage change in income %ΔY
Interpretation of in Income Elasticity of Demand:
➢ Sign Shows (Types of Good)

• If Answer is “Negative”, it is an inferior good. (Increase in income, decrease its demand)
• If Answer is “Positive”, it is a normal good. (Increase in income, increase its demand)
➢ Numeric value Shows (Elasticity of demand)

• If YED is < +1, (0 to +1) it means good is basic necessity. (Income inelastic)
• If YED is = +1, it means good is normal. (Unit elastic)
• If YED is > +1, it means good is luxury. (Income elastic)
Example-03: (Numerical)
A person’s income increases from Rs. 10,000 to Rs.15,000.
As a result, their demand for a product goes from 50 units to 40 units. (Using Arc method)
Answer:
Income Quantity Demand
10,000 50
15,000 40

PED = η = Q1−Q0 × 𝑦1 +𝑦𝑜

Q1+Q0 𝑦1−𝑦0
40−50 15,000+10,000
PED = η = × = -0.56 (inferior good having inelastic demand)
40+50 15,000−10,000
2.2: CROSS ELASTICITY OF DEMAND or CROSS PRICE ELASTICITY OF DEMAND:
Definition:
Cross elasticity of demand is the measure of the responsiveness of demand for a good A to a change
in price of good B.
OR
Cross Elasticity of Demand is the ratio of the percentage change in quantity demanded of good A to
the percentage change in price of good B.
% Δ Qd A
XED = percentage change in Quantity demanded of good A =
percentage change in price of good B % Δ Pof B
Interpretation of Sign in Cross Elasticity of Demand:

• If Answer is “Positive”, it is substitute good. (Positive Cross Elasticity),
(As the demand for one product moves in the same direction to the change in price of other
product.) e.g., Coke and Pepsi, butter and margarine.
• If Answer is “Negative”, it is complementary good. (Negative Cross Elasticity)

(As the demand for one product moves in the opposite direction to the change in price of
other product).
e.g., cell phone and charger, shoe pair and shoelaces.
• If Answer is “Zero”, goods are independent. (Zero Cross Elasticity)

e.g., Shoe and Apple
Unlike price elasticity of demand, the coefficient of cross elasticity of demand may be positive or
negative.
Example-04: (XED of Substitute good)
Price of Good A Quantity Demand of Good B

110 200
100 150
XED = Q1−Q0 × 𝑃1 +𝑃𝑜 =

Q1+Q0 P1−𝑃0
100+110
150−200 × = +3 (Positive sign shows that the products are substitutes.)
150+200 100−110

Example-05: (XED of Complement good)
Price of Good A Quantity Demand of Good B

100 200
110 150
XED = Q1−Q0 × 𝑃1 +𝑃𝑜 =
Q1+Q0 P1−𝑃0
110+100
150−200 × = -3 (Negative sign shows that the products are complements.)
150+200 110−100
PART-03: PRICE ELASTICITY OF SUPPLY
3.1: DEFINITION AND DEGREE OF ELASTICITY OF SUPPLY:
Definition of Price Elasticity of Supply:

Price elasticity of supply is the measure of the responsiveness of supply to a change in its price.
OR
Price Elasticity of Supply is the ratio of the percentage change in quantity supplied to the percentage
change in price of a good.
PES (η) = percentage change in Quantity supplieded = %%Δ ΔQsP = QQ1−Q × 𝑃1P1−𝑃
0 +𝑃𝑜
percentage change in Price 1+Q0 0
Degree of Elasticity of Supply:
S
1) Perfectly Inelastic Supply: Price
P1
• If quantity supplied of a good does not
change with change in price, it is called
Perfectly inelastic supply.
• (Supply is totally unresponsive by P0
change in price)
• ES = 0
• Slope of Supply curve is vertical, parallel
to y-axis
O Q0 Quantity Supplied

S
2) Inelastic/Less elastic Supply: Price
• If percentage change in quantity P1
supplied is lesser than percentage
change in price, it is called Inelastic
supply.
• ES < 1. P0
supply curve will be sharp/steeper.
Price QS
100 50
200 60
Q0 Q1 Quantity Supplied
(Arc method): O
Ans: ES = +0.27 (Inelastic)
Price S
3) Unit/Unitary Elastic Supply:
P1
supplied is equal to percentage change
in price, it is called Unit elastic supply
• PES = 1. P0
Price QS
100 50
200 100
(Arc method): Q0 Q1
O
Ans: Es = + 1 (Unitary Elastic) Quantity Supplied
Price
4) Elastic Supply:
supplied is greater than percentage
change in price, it is called elastic S
supply. P1
• ES > 1. P0
• supply curve will be shallow/flatter.
Price QS
100 50
200 110
Q0 Q1
(Arc method): O
Quantity Supplied
Ans: Es = + 1.125 (Elastic)

Price
5) Perfectly Elastic supply:
• A nominal (minuscule) change in price

will largely (infinitely) affect the demand
for the product., it is called Perfectly
elastic supply P0 S
• the demand curve will be parallel line to

the horizontal axis
• PES = ∞ (infinity)
0 Q0 Q1
Quantity Supplied
i. If a linear supply curve intersects the price axis, the curve is elastic at all points.
ii. If a linear supply curve intersects the quantity axis, the curve is inelastic at all the points.
iii. If a linear supply curve intersects the origin, the elasticity is unity at all pints along supply
curve.
Note: in case of non-linear supply curve these rules are not compatible.
3.2: DETERMINANTS/FACTORS AFFECTING ELASTICITY OF SUPPLY:
• The degree of elasticity of supply depends how promptly producers can respond to the change in
demand in a market.
• If the supply of a good can be expanded or contracted comparatively easily in response to any
change in price, then it is elastic.
• If, however, supply remains comparatively fixed despite to any change in price, then supply in
inelastic
Cost of Production:
• If cos of production is low, its supply will be elastic because it’s easy for producer to produce
more goods.
• If cos of production is high, supply will be inelastic
The number of firms in the industry.

• The greater the number of firms in an industry, the more elastic is the industry supply. As
firms can respond to change in demand fairly easily.
• Lower the seller in the market, demand will be inelastic

The availability of stock:

• If stocks are available with firms, then supply will be relatively more elastic because an
increase in demand can be met with an increase in supply without any change in structure
etc.
• If business has no stock, so it cannot fulfil more demand making supply inelastic
Existence of spare capacity:

• If the industry is operating below full capacity or it has spare capacity within existing
structure, then supply will be more elastic, because firm can increase supply by using vacant
factors.
• Conversely, if firm is already using its available resources at its full capacity, the supply will
be inelastic
Ease of switching resources:

• If the firm has ability to switch its factors of production to other products, the supply will be
elastic, because firm can respond to any change of demand in a market.
• Conversely, if firm has such resources which cannot be used in production of other goods, the
supply will be inelastic.
Time:
• Some goods take short time to complete their production process, have elastic supply. E.g.,
industrial goods
• Conversely some goods take long time to be completed, have inelastic supply. E.g.,
agriculture goods
3.3: TIME AND ELASTICITY OF SUPPLY
In very short-run (or momentary or immediate market period)

supply is perfectly inelastic because there is insufficient time to change output
In short-run/short time
Although the plant capacity is fixed, with little alterations in techniques of
production or with more efficient use of resources, supply can be adjusted up to a little extent, and
supply is therefore relatively inelastic
In long-run
In long run or long period all required adjustment can be made, including change in structure of the
building, plant size etc., in order to meet any change in demand and therefore supply will be highly
elastic.
Time Supply
Momentary Perfectly inelastic
Short-run Inelastic
Long-run Elastic

PART-04: PRICE INSTABILITY AND ROLE OF GOVERNMENT
4.1: PRICE INSTABILITY:
Prices are most volatile (instable) when supply and demand both are inelastic
Example#1 Analysis of Corn Market (Price Instability)
Internationally market for corn fluctuate greatly

Inelastic Demand & Supply:
throughout the year
Effect on Supply: Price S1 S0
• Supply of corn is uncertain due to good P1
or bad harvest. E1
Effect on Demand:
• Demand for corn is inelastic (change in P0 E0
price more than change in quantity)
• Many food processes rely on corn and
D0
cannot substitutes other grain for it.
O Q1 Q0 Quantity
4.2: COBWEB THEORY:
The cobweb theorem is an economic model which explains that how little economic shocks can swell
up due to producer’s behaviour. Essentially, it is the result of information failure, where producers
decide their current level of output on the average price they obtained previously.
Assumptions of cobweb model

• We are dealing with agriculture industry, where time lags are involved in production.
• It is assumed that current prices will continue next year. Farmers have to decide, that how
much to produce a year in advance.
• Price is the function of preceding period’s supply
• The commodity concerned is perishable
• If price was low, then some farmers will no longer stay with this crop next year.

Diagram
The diagram below demonstrates how the price mechanism adjusts price and quantity from one
year to the next. COBWEB THEORY:
S0
Price
P1
P3
P2
D0
O Q1 Q3 Q2 Quantity
Explanation:
1. First cycle:
Suppose due to bad harvest supply of Rice decreases below equilibrium at Q1 and price reaches
to P1 above equilibrium.
2. Second cycle:
Due to higher price in cycle1, this induced the farmer to produce more Rice at Q2. The excess
supply reduced the price at P2.
3. Third cycle:
In response to the low price in second cycle, farmers got disappointed and some farmers left the
production of Rice, this reduces the supply of Rice in this cycle. This low production again pushes
the price up at P3.
Price and quality will continue to oscillate (swing), though the market will approach equilibrium
at the market clearing price.
• Convergent case of cobweb:

At the equilibrium point, if the demand curve is more elastic than the supply curve, we get the
price volatility falling, and the price will converge on the equilibrium.
• Divergent case of cobweb:

Price will diverge from the equilibrium when the supply curve is more elastic than the demand
curve.
• Perpetual case of cobweb:

Fluctuations may also remain of constant magnitude, if the supply and demand curves have
exactly the same slope or elasticity of demand is exactly equal to the elasticity of supply.

4.3: GOVERNMENT POLICIES TO INCREASE PRICE STABILITY:
Buffer stock scheme:

Price of a good is the main source of income for individuals and firms that work in the agriculture
sector.
Therefore, in order to ensure that they receive a stable, predictable income and Prevent
farmers/producers going out of business because of a drop in prices, the government often acts to
stabilize the price. This is usually done by the government through a buffer stock scheme,
Buffer Stock Scheme:

(S0)
Price
(S1)
E0
P0
E1
P1
(D)
Q0 Q1
Quantity
Disadvantages of Buffer Stock Scheme:
• Higher opportunity cost:

The main disadvantage that comes from this policy is the upfront cost of purchasing excess
stock above the market price. This requires capital that, as we have seen through the concept
of opportunity cost, could be spent meeting other policy objectives.
• Apprehension of excess production:

It can also encourage over-production of certain commodities, as the pricing signal of the
market mechanism is no longer in action.
• Administrative concerns:
There are also a lot of administrative and storage costs associated with the maintaining levels
of buffer stocks.

PART-05 MULTIPLE CHOICE QUESTIONS
3.1 Which of the following products is likely to have the lowest price elasticity of demand?
(a) Salt (b) Cars
(c) Houses (d) apples
3.2 Which of the following has the most inelastic demand?

(a) Fuel (b) Wheat
(c) Meat (d) Sugar
3.3 Production and employment in which of the following industries would be least affected by recession?
(a) Sugar (b) Steel
(c) Garments (d) Vehicles
3.4 If the market price of a product increases from Rs. 35 to Rs. 40 and in response, the quantity demanded
decreases from 1400 units to 1200 units, the value of its price elasticity of demand is:
(using Arc method)
(a) 0.9 (b) 1
(c) 1.1 (d) 1.2
3.5 Which of the following is NOT a method for the measurement of price elasticity of demand?
(a) Total outlay (b) Total savings
(c) Point method (d) Arc method
3.6 If the price of a good fell by 10% and, as a result, total expenditure on the good FELL by 15%, the
demand for the good would be described as
(a) perfectly inelastic (b) Inelastic
(c) unitary elastic (d) elastic
3.7 When there is a small change in the quantity demanded of a product in response to a small charge in
its price. Elasticity will be known as:
(a) Point elasticity (b) Arc-elasticity
(c) Gross elasticity (d) None of the above
3.8 If the demand for a good is price inelastic, which ONE of the following statements is correct?
(a) If the price of the good rises, the total revenue earned by the producer increases.
(b) If the price of the good rises, the total revenue earned by the producer falls.
(c) If the price of the good falls, the total revenue earned by the producer increases.
(d) If the price of the good falls, the total revenue earned by the producer is unaffected.
3.9 Elasticity of demand depends upon:

(a) proportion of income spent on the (b) income elasticity of demand.
particular good
(c) substitution elasticity of demand. (d) all of the above.

3.10 An inferior good is one which has an income elasticity of demand that is
(a) positive but less than unity (b) negative
(c) unitary (d) zero
3.11 If percentage change in quantity demanded is greater than percentage change in price demand said
to be:
(a) Less elastic (b) More elastic
(c) Inelastic (d) Perfectly elastic
3.12 If total consumer’s expenditure increases in response to price fall, demand is:
(a) Relatively elastic (b) Relatively inelastic
(c) Unitary elastic (d) All of the above
3.13 If the price of a good fell by 20% but total expenditure on the good remained the same, the demand
curve could be described as
(a) Perfectly elastic (b) Elastic
(c) Perfectly inelastic (d) Unitary elasticity
3.14 The horizontal demand curve parallel to x-axis implies that elasticity of demand is:
(a) Zero (b) Infinite
(c) equal to one (d) between zero and one
3.15 Increase in price, increase Total revenue, the demand is?

(a) Elastic (b) Perfectly elastic
(c) Inelastic (d) Perfectly inelastic
3.16 Increase in price, increase Total revenue, the demand is Elastic.

(a) True (b) False
3.17 If the demand is perfectly inelastic, then curve is (Select any TWO)
(a) Horizontal (b) Parallel to x-axis
(c) Vertical (d) Parallel to y-axis.
3.18 If the quantity of a commodity demanded remains unchanged as its price changes the coefficient of
price elasticity of demand is:
(a) Greater than one (b) Equal to one
(c) Smaller than one (d) Equal to zero
3.19 Let quantity demanded decreases from 30 to 10 as price of the product increases from 200 to 400.
Price elasticity of demand would be:
(a) 2.5 (b) 1.5
(c) 0.5 (d) zero

3.20 In geometric method, demand is elastic from center to lower demand curve
(a) True (b) False
3.21 If price of one good A decrease, demand for its complement good B increase, will make demand
inelastic.
(c) True (d) False
3.22 A shop sells chocolate birthday cakes. When the price was Rs.15 it sold 40 cakes. It reduced the price
to Rs.10 and sold 60 cakes. What can be concluded from this?
(a) The firm will make less profit because the price has fallen.
(b) The firm will make more profit because sales have increased.
(c) The price elasticity is inelastic because demand only increased by 50 %.
(d) There is unit price elasticity because the firm’s revenue remained the same after the price
Change
3.23 If price increase from 2 to 4. Use percentage method to solve. (Calculate PED)
4 8 12
(a) 3/5 (b) 2/5
(c) 1/5 (d) 2/6
3.24 Select any TWO options in which demand is totally unaffected by change in price.
(a) Demand is perfectly inelastic (b) Demand is perfectly elastic
(c) Demand curve is horizontal (d) Demand curve is vertical
3.25 If the price of a good fell by 5% and as a result, total expenditure on the good fell by 10% the demand
for the good would be:
(a) Elastic (b) Unitary elastic
(c) Inelastic (d) Perfectly elastic
3.26 A firm with existing sales of 1,000,000 units per annum is planning to increase the price of a product
from Rs. 100 to Rs. 120 per unit. If price elasticity of demand for that product is 1.25, assuming no
other changes, the sale of the firm after price increase would be:
(a) 1,250,000 units (b) 750,000 units
(c) 1,200,000 units (d) 800,000 units
3.27 If PED is -2.5, it means good is , having demand.

(a) Giffen, Elastic (b) Inferior, Elastic
(c) Normal, Inelastic (d) Normal, elastic

3.28 If YED is -0.75, it means good is , having demand.

(a) Inferior, Elastic (b) Inferior, Inelastic
(c) Normal, Inelastic (d) Normal, elastic
3.29 If XED is +1.75, it means good is , having demand.

(a) Complementary, Elastic (b) Independent, Inelastic
(c) Substitute, Inelastic (d) Substitute, elastic
3.30 Lithium is an essential metal for the production of electric cars. Following a 10% increase in the price
of lithium, supplies increase by 15%. This led to a 5% increase in the price of electric cars.
What is the price elasticity of supply (PES) for lithium?
(a) 0.75 (b) 1.50
(c) 2.5 (d) 0.25
3.31 The price of bread rose by 5% and the quantity demanded fell by 4%. What was the price elasticity
of demand for bread?
(a) -0.75 (b) -0.6
(c) -0.8 (d) -0.25
3.32 A business, currently selling 10,000 units of its product per month, plans to reduce the retail price
from £1 to £0.90. It knows from previous experience that the price elasticity of demand for this
product is -1.5. Assuming no other changes, the sales which the business can now expect will be
(a) 8,500 units (b) 9,000 units
(c) 11,000 units (d) 11,500 units
3.33 If a straight-line demand curve is tangent to a curvilinear demand curve, the elasticity of the two
demand curves at the point of tangency is:
(a) The same (b) Different
(c) Can be the same (d) It depends on the location of the point of
tangency
3.34 In a country where the demand for petrol (gas) is price-inelastic, the incidence of any increase in
petrol tax will be mainly on
(a) the company that refines the oil. (b) the motorist who buys the petrol.
(c) the petrol station that sells the petrol. (d) the wholesale company that stores the
petrol.
3.35 A negative income elasticity of demand for a commodity indicates that as income increase then
amount of the commodity purchased:
(a) Rises (b) Falls
(c) Remain the unchanged (d) Any of the above
3.36 Very small or zero Co-efficient of price elasticity of demand means that the good is:
(a) a necessity (b) a comfort
(c) a luxury (d) any of the above

3.37 Price elasticity coefficient of 0.2 implies that the %age change in quantity for a 5%
change in price will be:
(a) 0.2 (b) 2.5
(c) 5 (d) 1
3.38 Assume that a fall in price of a commodity form Rs10 to Rs.9 per unit results in an increase in weekly
sales from 100 units to 110 units. Price elasticity of demand would be: (Using Point method)
(a) 1.9 (b) Unity
(c) 2 (d) Zero
3.39 If the amounts of two commodities purchased both increase or decrease when the price of one
change, the cross elasticity of demand between them is:
(a) Negative (b) Positive
(c) Zero (d) One
3.40 The standard measure for measuring demand and supply elasticity is
(a) Zero (b) Unity
(c) Infinity (d) Two
3.41 The income elasticity of demand for an income inferior good has an arithmetic sign.
(a) Positive (b) Zero
(c) Negative (d) No sign
3.42 Income elasticity of demand for inferior goods is always:

(a) Positive (b) Negative
(c) Zero (d) Infinity
3.43 Price elasticity of demand for Giffen goods is always.

3.44 Cross elasticity of demand for complementary goods is always.

3.45 From the demand schedule below, the price elasticity of demand following a fall in
price from Rs 25 to Rs. 20 is: (Using Point method)
Price (Rs.) Quantity (units)

30 15
25 20
20 25
15 30

(a) -1 (b) -1.25

(c) -1.5 (d) -1.75
3.46 The quantity demanded for Alpha decreases from 300 units to 250 units, when the price of Beta
increases from Rs. 50 to Rs. 55. Determine the Cross Price Elasticity of Demand (XED)
(a) – 1.91 (b) + 1.91
(c) – 2.91 (d) +0.91
3.47 With the drop in price of smartphones from Rs. 80,000 to Rs. 70,000, the quantity demanded by the
consumers, in a particular market, increases from 20,000 phones to 30,000 phones per month. Calculate
the elasticity of demand under percentage method and identify the type of elasticity
(a) +3 (b) 2.5
(c) – 2.5 (d) -3
3.48 Which of the following is NOT a method for the measurement of price elasticity of demand?
(a) Total outlay (b) Total savings
(c) Point method (d) Arc method
3.49 Which of the following is NOT an importance of Elasticity of demand.

(a) For finance minister (b) Guidance for monopolist
(c) Income spent on goods (d) Price determination
3.50 Demand for cars decrease when their prices increase. However, demand may also decrease when
income of consumers decrease. Price and income elasticities of cars are said to be:
(a) elastic; negative (b) elastic; positive
(c) inelastic; negative (d) inelastic; positive
3.51 If cross elasticity of demand between Goods X and Y is negative then:

(a) the demand for both X and Y is price inelastic
(b) X and Y are complements
(c) X and Y are substitutes
(d) the demand for both X and Y is price elastic
3.52 Which one of the following statements about the elasticity of supply is not true?
(a) It tends to vary with time.
(b) It is a measure of the responsiveness of supply to changes in price.
(c) It is a measure of changes in supply due to greater efficiency.
(d) It tends to be higher for manufactured goods than for primary products
3.53 The price of a product is Rs. 3 and the quantity supplied is 10 units. When price is increased to Rs. 7
the quantity supplied increases to 12 units. The supply is:
(a) perfectly elastic (b) elastic
(c) inelastic (d) perfectly inelastic

3.54 When only a small proportion of a consumer's income is spent on a good

(a) the demand for the good will be highly price elastic
(b) the good is described as 'inferior'
(c) a rise in the price of the good will strongly encourage a search for substitutes
(d) the demand for the good will be price inelastic
3.55 Over a long period of time:

(a) demand becomes more elastic and supply becomes less elastic.
(b) demand becomes less elastic and supply becomes more elastic.
(c) both demand and supply become more elastic.
(d) both demand and supply become less elastic
3.56 If the demand for a good is price elastic, a fall in price will lead to
(i) a rise in sales
(ii) a fall in sales
(iii) a rise in total expenditure on the good
(iv) a fall in total expenditure on the good
Which of the above are correct?
(a) (i) and (iii) only (b) (i) and (iv) only
(c) (ii) and (iii) only (d) (ii) and (iv) only
3.57 Main determinant of Elasticity of Demand is:

(a) Time period (b) Brand loyalty
(c) Possibility of substitution (d) All of the above
3.58 Demand for cars decrease when their prices increase. However, demand may also decrease when
income of consumers decrease. Price and income elasticities of cars are said to be:
(a) elastic; negative (b) elastic; positive
(c) inelastic; negative (d) inelastic; positive
3.59 As the period of time to supply a product into a market in order to meet the demand is increasing
the elasticity of supply also.
(a) Increasing (b) Decreasing
(c) Remains same (d) None of the above
3.60 A shift to the right in the supply curve of a good, the demand remaining unchanged, will reduce its
price to a greater degree.
(a) The more elastic the demand curve (b) The less elastic the demand curve
(c) The elasticity of demand is unity (d) Supply curve is more inelastic
3.61 Elasticity supply of perishable goods is generally:

(a) Perfectly elastic (b) More elastic
(c) Unitary elastic (d) Less elastic

3.62 In the below diagram, curve “C” having elasticity of supply.
(i) Less elastic

(ii) More elastic
(iii) Unitary elastic
(iv) Inelastic
(a) (i) & (iv) (b) (i) & (iii)

(c) (iii) (d) (iii) & (iv)
3.63 Elasticity of supply of durable goods is generally

(a) Unitary elastic (b) More elastic
(c) Inelastic (d) Less elastic
3.64 In partial adjustment can be made to enable producers to increase the supply of the product.
(a) very short run (b) short run
(c) long run (d) All of these
3.65 In , it can be expected that the whole supply position will change.
(a) very short run (b) short run
(c) long run (d) All of these
3.66 In the below diagram supply curve represents.
(i) Perishable good

(ii) Perfectly inelastic good
(iii) Normal good
(iv) Durable good

(a) (i) & (ii) (b) (ii) & (iv)

(c) (ii) & (iii) (d) (ii) & (iv)
3.67 The elasticity of supply in momentary or immediate market period is

(a) perfectly inelastic (b) perfectly elastic
(c) elastic (d) Inelastic
3.68 The supply of a particular product will be more inelastic.

(a) The longer it takes to produce the good
(b) The longer the good can be store
(c) The greater the number of firms in the industry
(d) The greater the amount of spare capacity in the industry
3.69 If a linear supply curve intersects the price axis, the curve is inelastic at all points
(a) True (b) False
3.70 Some goods take long time to complete their production process, having elastic supply.
(a) True (b) False
3.71 If business has no stock, so it cannot fulfil more demand making supply inelastic
(a) True (b) False
3.72 Which of the following is NOT an assumption of COBWEB theory.

(a) Concept relate to agriculture sectors (b) No time lag is involved in production
(c) Concept relate to Perishable goods (d) Price is the function of previous year’s
supply
3.73 The oscillations in a cobweb cycle will decay towards equilibrium if.
(a) The supply is perfectly inelastic
(b) The supply is perfectly elastic
(c) The supply curve is steeper than the demand curve.
(d) The demand curve is steeper than the supply curve
3.74 Price convergence case of cob-web model depends upon:

(a) Elasticity of supply is greater than elasticity of demand
(b) Elasticity of demand is greater than elasticity of supply
(c) Elastic of demand is perfectly elastic
(d) Elasticity of supply is perfectly less elastic
3.75 Price divergence case of cob-web model depends upon:

(a) Elasticity of supply is greater than elasticity of demand
(b) Elasticity of demand is greater than elasticity of supply
(c) Elastic of demand is perfectly elastic
(d) Elasticity of supply is perfectly less elastic
3.76 Buffer stock helps government:

(a) To protect producers
(b) To encourage production of a particular product
(c) To maintain price stability into market
(d) All of above

3.77 For buffer stock, government may face:

(a) Over production of a particular crop
(b) Less opportunity cost
(c) Less administrative expense
(d) b & c
3.78 For price stability buffer stock policy can be used by government for:
(a) Agricultural goods (b) Primary goods
(c) Perishable goods (d) All of the above
ANSWER KEY
3.1 A 3.2 B 3.3 A 3.4 C

3.5 B 3.6 B 3.7 A 3.8 A
3.9 D 3.10 B 3.11 B 3.12 A
3.13 D 3.14 B 3.15 C 3.16 B
3.17 C,D 3.18 D 3.19 B 3.20 B
3.21 A 3.22 D 3.23 A 3.24 A,D
3.25 C 3.26 B 3.27 D 3.28 B
3.29 D 3.30 B 3.31 C 3.32 D
3.33 A 3.34 B 3.35 B 3.36 A

3.37 D 3.38 B 3.39 A 3.40 B
3.41 C 3.42 B 3.43 A 3.44 B
3.45 B 3.46 A 3.47 D 3.48 B
3.49 C 3.50 B 3.51 B 3.52 C

3.53 C 3.54 D 3.55 C 3.56 A
3.57 D 3.58 B 3.59 B 3.60 D
3.61 D 3.62 C 3.63 B 3.64 B

3.65 C 3.66 A 3.67 A 3.68 A
3.69 B 3.70 B 3.71 A 3.72 B
3.73 C 3.74 B 3.75 A 3.76 D

3.77 A 3.78 D

TEST-03
Q-1) Increase in price, increase Total revenue, the demand is?
a) Elastic b) Perfectly elastic
c) Inelastic d) Perfectly inelastic
Q-2) If the income elasticity of a demand for a good is positive but less than 1, then the good will be;
a) Luxuries b) Substitute
c) Necessities d) Inferior
Q-3) If demand is elastic and supply is inelastic then decrease in supply will:
a) Increase in price equilibrium is more than increase quantity equilibrium
b) Increase in price equilibrium is less then decrease quantity equilibrium
c) Decrease in price equilibrium is more than decrease quantity equilibrium
d) Decrease in price equilibrium is less then decrease quantity equilibrium
Q-4) If the demand curve is perfectly inelastic then curve will be (Select TWO)
a) Horizontal b) Vertical
c) Parallel to x-axis d) Parallel to y-axis
Q-5) If elasticity is zero then goods are?

a) Dependent b) Independent
Q-6) The demand for a good rise from 20,000 to 25,000 following a reduction in price from $20 to $18.
What is the price elasticity of demand? (Using the point elasticity of demand method)
a) -2.1 b) -2.5
c) +2.1 d) +2.5
Q-7) Sales of Good T are currently 10,000 per year, and income elasticity of demand for Good T is + 1.5. If
household incomes rise by 4%, what will be the new annual sales of Good T?
a) 10,600 b) 10,400
c) 9,600 d) 9,400
Q-8) When only a small proportion of a consumer's income is spent on a good:

a) The good is described as 'inferior'
b) The good is a luxury good
c) The demand for the good will be highly price elastic
d) The demand for the good will be price inelastic
Q-9) If supply curve is more elastic than the demand curve then price will.
a) Convergent case of cobweb b) Divergent case of cobweb
Q-10) The demand for a product will tend to be inelastic when:

a) It has very few close substitutes
b) It has low demand.
c) It tends to be purchased by people on subsistence incomes
d) It has a wide range of different uses

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CH-03: ELASTICITY OF DEMAND AND SUPPLY

“ELASTICITY OF DEMAND AND SUPPLY”

1.1: DEFINITION AND DEGREE OF ELASTICITY OF DEMAND 65

PART-02: OTHER VARIANTS OF ELASTICITY OF DEMAND

2.1: INCOME ELASTICITY OF DEMAND (YED): 73

PART-03: PRICE ELASTICITY OF SUPPLY

3.1: DEFINITION AND TYPES OF ELASTICITY OF SUPPLY: 75

PART-04: PRICE INSTABILITY AND ROLE OF GOVERNMENT

4.1: PRICE INSTABILITY: 79

PART-05: MULTIPLE CHOICE QUESTIONS & TEST-03

PRC-03: PRINCIPLES OF ECONOMICS | 64

Types: Price Elasticity of demand (PED)

PART-01: ELASTICITY OF DEMAND

1.1: DEFINITION AND DEGREE OF ELASTICITY OF DEMAND

Definition of Price Elasticity of Demand (η):

percentage change in Quantity demanded % Δ Qd

Estimation/Types of Elasticity of Demand:

b) Income elasticity of demand:

c) Cross-elasticity of demand or elasticity of demand between related goods:

PRC-03: PRINCIPLES OF ECONOMICS | 65

Degree of Elasticity of Demand:

(Demand totally unaffected/unresponsive P0

• PED = 0 Demand curve (D)

2) Inelastic/Less elastic Demand: Price

• Slope of Demand curve is sharp/steeper

3) Unit/Unitary Elastic Demand: P1

PRC-03: PRINCIPLES OF ECONOMICS | 66

4) Elastic Demand: Price

• If percentage change in quantity

• PED > 1. Demand curve (D)

• Slope of Demand curve is

5) Perfectly Elastic Demand: Price

• Slope of Demand curve is horizontal,

PRC-03: PRINCIPLES OF ECONOMICS | 67

1.2: METHODS TO MEASURE ELASTICITY OF DEMAND:

1. Percentage Method (Point Elasticity of Demand and Arc Elasticity of Demand).

(i) Point method: Price

When elasticity of demand is to be measured for

PRC-03: PRINCIPLES OF ECONOMICS | 68

(ii) Arc method:

Example-02: (Arc method)

Interpretation of Price Elasticity of Demand:

2) Numeric value Shows (Elasticity of demand)

PRC-03: PRINCIPLES OF ECONOMICS | 69

2) Total Revenue/Total Expenditure/Total Outlay Method:

• Unit elastic Demand:

Relationship between Price elasticity of Demand and Revenue.

The effect of a price change on revenue depends on the elasticity of demand.

PRC-03: PRINCIPLES OF ECONOMICS | 70

(3) Geometric Method: (Geometrical measure of point elasticity of demand)

PED at point A = 𝐴𝐸 = Elastic (E > 1)

1.3: DETERMINANTS OF ELASTICITY OF DEMAND:

2. The possibility of substitution:

3. The case of complementary goods:

PRC-03: PRINCIPLES OF ECONOMICS | 71

4. Habit of brand loyalty (Addiction):

6. Proportion of income spent for a product:

1.4: APPLICATION OR IMPORTANCE OF ELASTICITY OF DEMAND

The importance of elasticity of demand can be viewed from the following:

For Finance Minister (taxation)