Micro

McEachern

Elasticity of Demand
 Elasticity of Demand

• Elasticity of demand is defined as the degree of

responsiveness of demand of a commodity to the
change in its determinants.
• Mathematically ,it means the
percentage change in quantity
demanded of a commodity to
a percentage change in any of
the variables that determine
demand for the commodity
 Types of elasticity of demand

• Price elasticity of demand

• Cross elasticity of demand
• Income elasticity of demand
Price Elasticity of Demand
 Elasticity
– Responsiveness
 Price elasticity of demand
– Consumers’
responsiveness to a
change in price
– Percentage change in
quantity demanded
divided by percentage
change in price
Price Elasticity of Demand

Price elasticity of demand =

% change in quantity demanded
% change in price

5
 Percentage or Proportionate
Method
Ed = Proportionate change in Q.D/Proportionate change in
price
=Change in Q.D/Original Q.D Change in Price/Original Price
=Q2 –Q1/Q1  P2-P1/P1
= Q/Q1P/P1
=Q/P x P/Q
• Income Ed

• Ey= Proportionate change in Q.Dx /Proportionate

change in income of consumer
• = Qx/ Y x Y/Q
• Cross Ed
Ec = Proportionate change in Q.Dx
/Proportionate change in price y
• = Qx/ Py x Py/Qx
1.Perfectly elastic demand
2.Highly elastic demand
3.Unitary elastic demand
4.Relatively inelastic demand
5.Perfectly inelastic demand

8
 A Perfectly Elastic Demand Curve
Price

ED =

4 D

0 Quantity
120 150
Perfectly Elastic –Unlimited quantities demanded at given price
 Degrees of elasticity of Demand

A highly Elastic Demand Curve

Price

ED > 1
3

D
0 120 160 Quantity demand
High Elasticity: A small change in the price of the commodity leads to a more than
proportionate change in the quantity demanded.
 Degrees of elasticity of Demand

A Unit Elastic Demand Curve

Price

ED = 1
4

3
D''

0 120 150 Quantity demand

Unit Elasticity:A change in the price of a good will bring about

an equal proportionate change in the
11 quantity demanded.
 Degrees of elasticity of Demand

A Relatively Inelastic Demand Curve

Price

4
ED < 1
3

D
0 120 140 Quantity demand
Relatively Inelastic: A change in price will bring about a less than proportionate change in
the quantity demanded
 Degrees of elasticity of Demand

A Perfectly Inelastic Demand Curve

D'
Price

3
ED = 0

0 120 Quantity
Perfectly Inelastic: The quantity demanded is totally unresponsive to changes in price that
means there is no change in quantity demanded when its price changes
 Factors Affecting Price Elasticity Of
Demand
• Price level
• Nature of the Commodity
• Availability of Substitutes
• Variety of uses of commodity
• Postponement
• Influence of habits
• Proportion of Income spent on a commodity
• Durability of commodity
• Time
 Measurement of Price Elasticity
• Point method
• Arc method
• Total outlay method
 Point Method
A
Ed= Portion below the point/ Portion above the point
E
Ed= EB/EA

O B
 The Point Method
• The formula for finding the coefficient of point
elasticity is:

e=

17
 The Point Method
• When 100 units are demanded at Rs5 and 90 units are
demanded at Rs6, the point coefficient is:
• e=

1 1
• e = 10/100 / 1/5
• e = 10/100 x 5/1 = 0.5
• Elasticity is therefore Inelastic < 1

18
 The Arc Method

The arc method should

always be used when there is
a proportionally large price
change. It averages the
elasticity over the distance
that is under consideration
on the demand curve.

19
 The Arc Method
• The formula for finding the coefficient of arc elasticity is:

q2 – q1 p2- p1

q1 + q2 p 1 + p2
2 2

20
 The Total Revenue Method

• The total revenue method is the simplest way

of telling whether demand is elastic or
inelastic.
• The total revenue that would be received by
sellers at various prices is found by
multiplying price by quantity demanded.

21
 Total outlay method
• Developed by A.Marshall
• New price and total expenditure compared
with original price & total expenditure
• Three situations:
• If P & T.E move in opposite direction, Ed>1
• If T.E remains the same whether P or ,Ed=1
• If P & T.E move in the same direction, Ed<1
 THREE POSSIBILITIES
Situation Price Q.D T.E Ed

I 5 20 100

4 30 120 Ed>1

II 5 20 100

4 25 100 Ed=1

III 5 20 100

4 22 88 Ed<1
• Measurement of price elasticity of demand by
total outlay method.doc
 The Total Revenue Method
• When total revenue
moves in the opposite
direction to the price
change, demand is
elastic i.e ep>1
• Example:
Price TR
Price TR

25
 The Total Revenue Method

• At Rs2 consumers demand 100 units and the

revenue equals Rs200.
• At Rs1 consumers demand 210 units and
revenue equals Rs 210.
• By price, Revenue . Demand is therefore
elastic.

26
 The Total Revenue Method
• Total revenue remains the same when prices
change if demand has unit elasticity.
• At Rs 4 consumer demand 75 units and the
revenue equals to Rs 300
• At Rs 3.75 consumer demand 80 units and the
total revenue equals to Rs 300
• By price, Revenue remains constant .Demand
is therefore unit- elastic.

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 The Total Revenue Method
• When total revenue moves in the same
direction to the price change, demand is
inelastic i.e ep<1.
• At Rs 3.75 consumer demand 80 units and
the revenue equals to Rs 300
• At Rs 3.50 consumer demand 84 units and the
total revenue equals to Rs 294
• By price, Revenue .Demand is therefore
Inelastic.
 Categories of ED
 If %∆q < %∆p
– ED between 0 and 1
– Inelastic D
 If %∆q > %∆p
– ED greater than 1
– Elastic D
 If %∆q = %∆p
– ED = 1
– Unit elastic D
 The Point Method
• The following linear equations represent
different possible demand functions for three
commodities ,X,Y and Z.
Dx=240-3P Dy=320-50P Dz=20+25P
i) What are the associated price elasticities at
P=4?Comment on the values obtained.
ii)Which of the three is a Giffen good?
 The Point Method
• The following linear equations represent
different possible demand functions for three
commodities ,X,Y and Z.
Dx=240-3P Dy=320-50P Dz=20+25P
i) What are the associated price elasticities at P=4?
Comment on the values obtained.
ii) Which of the three is a Giffen good?
Ans:-0.0526 ,-1.667 , 0.833
Com. Z, as price Ed is positive.
 The Arc Method
• Suppose the price of a commodity falls from
Rs 6 to Rs 4 per unit and due to this quantity
demanded of the commodity increases from
80 units to 120 units. Find out the price
elasticity of demand by using arc method.
 The Total Revenue Method
• Suppose price of a good falls from Rs 10 to Rs 8
per unit.As a result,its quantity demanded
increases from 80 units to 100 units .Tell whether
demand for a good is elastic ,inelastic or unit
elastic.
• Suppose price of a commodity rises from Rs 15 to
Rs16 per unit.As a result,its quantity demanded
falls from Rs 100 units to 80 units.Find out
whether price elasticity of demand is more than
one,equal to one or less than one.
• Q 1.Consider two goods X&Y. There was no change in price of
X, but its demand was seen to fall from 6000 to 5500 units. On
analysis it was found that price of another commodity Y
decreased from 250 to 225. Find out Ec and the relationship
between two goods.
• Q.2. Movers & Shakers Company Pvt.ltd. Concludes that the
demand fn. For its product X is:
• Qx=1000-0.2Px+0.5 Py+0.04Y+0.01A
• Find out Qx, Ep, Ey, Ec, Ea
• Given that-Px=100, Py=120,Y=10000,A=6000
• Calculate Elasticity of demand for each variable
• And show which factor affects the most and the least in terms
of determining Ed.
• Reliance group of industries decided to invest
in stock X when the price was Rs 20. Now that
the price rose to Rs. 40. The no. of investment
in stock Y purchased increased from 200 to
420. Which method of elasticity would be
appropriate to use here.
• Interpret your result.
• Q. Price Ed for a product is unity. A household buys
25 units of this product at a price of Rs.5.If price of a
product rises to Rs.6 per unit, how much of the
product will be bought by the household. 20 , 5

• Q. As a result of a fall in the price of a commodity

from Rs.7 per kg. to Rs.5, the T.E on it increases from
Rs. 2100 to Rs.3500. Calculate price Ed.
 Predicting change inQty. Demand
• Suppose the manager knows that the Price Ed
for a company’s product is = 2.5 over the
ranges of prices currently being considered by
the firm’s marketing dept. The manager is
considering decreasing price by 8% and wishes
to predict the % by which Q.D will increase.
a) 20% b) 25% c) 15% d) 10%
 Predicting change in price
• Suppose a manager of different firms faces a price
Es= 0.5 over the range of prices the firm would
consider changing for its product. This manages
wishes to stimulate sales by 15% . The manager is
willing to lower the price to accomplish the
increase in sales but needs to know the
percentage amount by which price must be
lowered to obtain the 15% increase in sales. Help
the manager in predicting the change in price.
 CLASS TASK-1
Predicting Supply
• Suppose a seller of a textile cloth wants to lower
the price of its cloth from Rs. 150 per metre to Rs
142 per meter. If its present sales are 2000
metres per month and further it is estimated that
its elasticity of supply for the product equals
-0.7.Show
a. Whether or not his total revenue will increase as
result of his decision to lower the price.
b. Calculate the exact magnitude of its new total
revenue.
 CLASS TASK-2
• A consumer purchases 80 units of a
commodity when its price is 1 $ per unit and
purchases 48 units when its price rises to 2 $
per unit. What is the price elasticity of
demand for the commodity?
 CLASS TASK-3
The demand function for a soft drink in general
is Q= 20-2P,
where Q stands for quantity and P stands for
price.
a. Calculate point elasticity at prices of 5 and 9.
 Class Task-4
• Last year, you were selling membership of
your health club at 400$ a year. You had 500
members. This year you wanted to boost sales
revenue and so you decided to reduce your
membership fee to 360$. The no. has risen to
525.
• Calculate the change in TR
• Find the relation between Ed & TR
 Class Task- 5
• The Bengal Tiger & the Old Curry House are
two Indian restaurants on the high street of a
large town in Mexico City. Last week the
Bengal tiger introduced a special mid-week
discount that reduced the average price of a
meal from 20$ to 18$ per person. The no. of
customers on that evening at the Old Curry
House fell by 20%.
Income Elasticity
of Demand
 Demand responsiveness to a change in
consumer income
 Percentage change in demand divided by
the percentage change in income that
caused it
 Inferior goods
– Negative income elasticity
 Normal goods
– Positive income elasticity
Income Elasticity of Demand
The Measure of responsiveness of demand for a commodity to the changes in
Income of a consumer
Cross-Price Elasticity
of Demand
 Responsiveness of D for one good to
changes in P of another good
 %∆ in demand for one good divided by
%∆ in price of another good
– If positive: substitutes
– If negative: complements
– If zero: unrelated
Cross Elasticity of Demand
The Measure of responsiveness of demand for a commodity to the changes
in price of its related goods- Substitutes or complementary
•If CED is (+), the two
goods are Substitutes

•If CED is (-), the two

goods are
complementary
 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.
• Q. In the following demand schedule, calculate the
Ed with Rs.4 as the initial price and 3 also.
Q.D P
15 3
12 4
9 5

Q. For each of the following equations, determine

whether Ed is elastic, inelastic and unitarily elastic
a. Q=100-4P, P=30
b. Q=1500-20P , P=5.7
c. P=50-0.1Q, P=20
• Q. Price Ed for a product is unity. A household buys
25 units of this product at a price of Rs.5.If price of a
product rises to Rs.6 per unit, how much of the
product will be bought by the household. 20 , 5

• Q. As a result of a fall in the price of a commodity from Rs.7

per kg. to Rs.5, the T.E on it increases from Rs. 2100 to
Rs.3500. Calculate price Ed.
 Calculate elasticity coefficients for
each and explain its meaning
• When the wage rate increased from 100 to 180 per hour, the
no. of job applicants rose from 200 to 280 people.
• When the price of cement in India increased by 20%, the
builders reduced the no. of apartments construct from 300 to
250 units.
• When the roi on borrowings increased by 6% the no. of
lenders for home loans reduced from 1000 to 400 for HDFC
Bank.
• The price of entrance tickets for Sunway lagoon which
decreased from 500 to 400 Rs. Caused a surge of visitors by
25%.
 Test Yourself
You have recently joined HAL and you want to
utilize your knowledge of M.E for the benefit of the
company. Which aspects of the company can you
correlate with the concept of elasticity of demand?