Report On Elasticity Of Demand

Submitted to: Submitted by:Dr. Sangeeta Yadav Rishav Pandey(322)

Priyanka Jain(319)Rahul Gusain(325)

Raman Verma(321)Rishabh Rawat(320)

Rohit Gera(318)Priyabrat Dehury(324)

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Executive Summary:-

1. What is Elasticity of Demand? Measure of the relationship between a change in the quantity

demanded of a particular good and a change in its price2. What are the types of Elasticity of Demand?

Price Elasticity of Demand Income Elasticity of Demand Cross Elasticity of Demand

3.What are the degrees of Elasticity of Demand? Perfectly inelastic demand Perfectly elastic demand Unitary elastic demand Elasticity less than 1 Elasticity greater than 1

4.What are the measurements of Elasticity of Demand? Point Method Arc Method

5.What are the factors affecting the Elasticity of Demand? Availability of substitutes Nature of the commodity’ Habit of the consumer Postponement of the consumption The number of uses of the commodity

6.What is the importance of Elasticity of Demand? Business Decision Importance to Monopolist Importance to International Trade Incidence of Taxation

7. Case Study on Health Club Goers

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Index:-

Serial No

Topic Page No.

1 Definition 42 Types of Elasticity of Demand 4

2.1 Price Elasticity of Demand 4-52.1.1 Classification of Price Elasticity of

Demand5-8

2.1.2 Measurement of Elasticity of Demand

8-9

2.1.3 Methods Of Measurement Of Elasticity Of Demand

9-13

2.2 Income Elasticity of Demand 142.2.1 Classification Of Income Elasticity

Of Demand14-15

2.3 Cross Elasticity of Demand 162.3.1 Types Of Cross Elasticity Of

Demand16-17

3 Factors Affecting Elasticity Of Demand

17-18

4 Importance of elasticity of Demand 18-195 Case Study 20-216 Bibliography 22

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1.Definition:-

Elasticity of demand refers to the degree of responsiveness of quantity demanded of a commodity to a change in any of its determinants, viz., price of the commodity, price of the other commodities and income of the consumers. It is a measure of how sensitive the quantity demanded of a commodity is to change in any of the factors influencing demand.

2.Types Of Elasticity Of Demand:-

There are many different types of elasticity of demand as they are types of economic variables determining demand. However, there are three main types of elasticity of demand:

Price elasticity of demand Cross elasticity of demand Income elasticity of demand

It is calculated by using the following formula:

2.1 Price Elasticity Of Demand

The price elasticity of demand is a measure of how much the quantity demanded changes when the price changes. Price elasticity of demand may be defined as the degree of responsiveness of quantity demanded of a commodity in response to change in its price. By degree here we mean the rate of change. Therefore, more precisely, price elasticity of

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demand refers to the ratio of percentage change in the quantity demanded of a commodity to a given percentage change in its price.

Thus, here ep denotes price elasticity of demand.

2.1.1 Classification Of Price Elasticity:-

There are five different kinds of price elasticity of demand:

Perfectly inelastic demand Perfectly elastic demand Unitary elastic demand Elastic demand Inelastic demand

1. Perfectly inelastic demand – when quantity demanded of a commodity does not respond to change in its price, then the elasticity of demand is zero.

The quantity demanded remains the same, irrespective of any rise or fall in the price of the commodity. No matter what the price, the same

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quantity is demanded. It is a case of perfectly inelastic demand. A demand curve of zero elasticity is known as perfectly or completely inelastic demand curve.

Cases of perfectly inelastic demand are very rare even in the cases of basic necessities of life like food because even demand for basic necessities changes because of change in price.

2. Perfectly elastic demand – when consumers are prepared to purchase all that they can get at a particular price but nothing at all at a slightly higher price, then the price elasticity of demand for a commodity is said to be infinite.

In this case, a very small fall in price causes the demand to increase to infinity(∞). A demand curve of infinite elasticity is known as perfectly or completely elastic demand curve. In this case, demand curve is perfectly elastic. Cases of perfectly elastic demand is extreme rare.

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3. Unitary elastic demand – when a given percentage change price of commodity causes an equivalent percentage change in the quantity demanded, then the elasticity of demand is said to be unity (or one). For example, if a fall in the price of a commodity by 10% causes an

increase in the amount purchased by 10%, the elasticity of demand is

equal to one.

4. Elastic Demand – when the percentage change in quantity demanded of a commodity exceeds the percentage change in its price,

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the elasticity of demand is greater than unity. Demand is said to be relatively elastic here. For example, if a fall in the price of a commodity by 10% causes an increase in amount demanded by 15%, the demand is said to be elastic.

5. Inelastic demand – Demand is inelastic when the percentage change in the quantity demanded of a commodity is less than the percentage change in its price.

The elasticity of demand here is less than unity. We say that demand for that good is relatively inelastic. For instance, if a fall in price of a commodity by 10% leads to an increase in quantity demanded by 8%, the demand is inelastic.

2.1.2 Measurement Of Elasticity Of Demand:-

Elasticity of demand for different goods is different. It is important to measure elasticity of demand in order to compare elasticity of demand for different goods. The measurement of elasticity of demand can be looked to from two viewpoints:-

Point elasticity Arc elasticity

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Point elasticity – when price elasticity of demand is measured at a point on a demand curve, it is called point elasticity.

Arc elasticity – when elasticity of demand is measured over a finite range or ‘arc’ of demand curve, it is called price elasticity of demand.

2.1.3 Methods Of Measurement Of Elasticity Of Demand:-

There are three methods of measurement of price elasticity of demand:-

Percentage or proportionate method Total expenditure method Point or geometric method

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1. Percentage or proportionate method – In this method, price elasticity of demand is measured by the ratio of percentage change in quantity demanded to percentage change in price of the commodity.

2. Total expenditure method – According to expenditure method, elasticity of demand can be measured by considering the change in total expenditure as a result of change in the price of the commodity

By using this method, we can categorise three types of elasticities:

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Elastic demand Inelastic demand Unitary elastic

Elastic demand – when a fall in the price of the commodity results in an increase in total expenditure and a rise in the price leads to decrease in total expenditure, elasticity of demand will be greater than one.

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Inelastic demand – when a fall in price of a commodity reduces total expenditure and a rise in price increases it, price elasticity of demand will be less than one.

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Unitary elastic – when total expenditure does not change with change in price of the commodity, the elasticity of demand is equal to unity.

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2.2 Income Elasticity Of Demand:-

Income elasticity of demand measures the degree of responsiveness of quantity demanded of a commodity to changes in income of the consumers. More precisely, income elasticity of demand may be defined as the ratio of proportionate change in income of the consumers.

Income elasticity of demand can be measured with the help of following formula:

2.2.1 Classification Of Income Elasticity Of Demand:-

Income elasticity of demand can be of three types:

Positive income elasticity Negative income elasticity Zero income elasticity

1. Positive income elasticity – income elasticity of demand is said to be positive when with increase in income of the consumers’, the amount purchased of a commodity increases and vice-versa. For most of the commodities income elasticity of demand is positive because an increase in income leads to an increase in quantity demanded.

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We can classify income elasticity into three categories:

a. Income elastic – if the percentage change in quantity demanded of a commodity is greater than the percentage change in income, ey will exceed unity. The demand for the commodity is said to be income elastic.

b.Income inelastic – if the percentage change in quantity demanded is smaller than the percentage change in income, ey will be less than unity. The demand for the commodity is said to be income inelastic.

c. Unit income elasticity – if the percentage in the quantity demanded is equal to percentage change in the income, ey will be equal to unity.

2. Negative income elasticity – income elasticity of demand is said to be negative when increase in income of the consumers leads to fall in the amount purchased of a commodity and vice-versa.

3. Zero income elasticity – income elasticity of demand may be zero in some exceptional in some cases. Zero income elasticity of demand for a good implies that a rise in income leaves quantity demanded unchanged. For instance, income elasticity of demand for salt may be zero because an increase in income beyond a certain level may not bring about a change in demand for inexpensive goods of necessities like salt.

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2.3 Cross Elasticity Of Demand

The degree of responsiveness of quantity demanded of one commodity to change in the price of another commodity is called cross- elasticity of demand. More precisely, cross-elasticity of demand is defined as the percentage change in quantity demanded of a commodity with respect to the change in the price of its related commodity.

Cross elasticity of demand can be measured with the help of the following formula:

2.3.1 Types Of Cross Elasticity Of Demand:-

Cross elasticity of demand is of three types as below:

1. Positive cross elasticity – cross elasticity of demand is said to be positive, when increase in price of the commodity (Y) leads to an increase in the demand for the other commodity (X). When two goods are substitutes for each other, cross elasticity will be positive because increase in price of one increases the demand for the other. For example, tea and coffee are substitutes.

2. Negative cross elasticity – cross elasticity of demand is said to be negative when increase in price of Y leads to a fall in the demand for X. Complementary goods have negative cross elasticity.

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3. Zero cross elasticity – cross elasticity of demand is said to be zero when a change in the price of one commodity (Y) does not affect the demand for another commodity (X).

3. Factors Affecting Elasticity Of Demand:-

There are many factors that determine the elasticity of demand. The main factors are:

1. Availability of substitutes – The most important determinant of the price elasticity of demand is the number and kind of substitutes available for a commodity. If a commodity has many close substitutes, its demand is likely to be elastic. Even a small fall in the price will induce more people to buy this commodity rather than its substitutes

2. Nature of the commodity – Another determinant of elasticity of demand is the nature of the commodity, i.e., whether the commodity is a ‘necessity’ or a ‘luxury’ or a ‘comfort’. Demand for necessity like food is generally inelastic as it is essential for life. On the other hand, ‘luxury’ and ‘comforts’ are not essential for life and their consumption can be postponed, thus, their demand is generally elastic. Hence, the demand for necessities is inelastic and the demand for luxuries and comforts is elastic.

3. Habits of the consumer – Price elasticity of demand depends also upon whether or not the consumers are habitual of using a commodity. If consumers are habitual of consuming some commodities, they will continue to consume them even at higher prices.

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4. Postponement of consumption – Elasticity of demand depends on the possibility of postponement of consumption as well. The consumption of clothing may be postponed and, therefore, a rise in its price may lead to a large fall in its demand. Hence, the demand for clothing may be elastic. But the consumption of food items cannot be postponed; therefore, their demand is inelastic.

5. The number of uses of a commodity – Elasticity of demand depends also upon the number of uses of a commodity can be put to. The greater is the number of uses to which a commodity can be put to, the greater will be its price elasticity of demand. If the price of the commodity is very high, consumer will purchase this commodity for the most important use only and, hence, the demand will be small.

4. Importance of elasticity of Demand

The importance of concept of elasticity of demand is as follows:

1. Business decision – The concept of elasticity of demand plays an important role in taking various decisions regarding prices and output. For instance, in deciding whether to increase the price or not, the firm should have an idea about price elasticity of demand for the products and its substitutes and its complements.

2. Importance to monopolist – A monopolist normally pursues the policy of price discrimination, i.e., charging different prices from different consumers. An idea of price elasticity of demand for his product by different consumers would be of great use to him. He would charge higher price from those consumers who have inelastic demand and lower prices from those consumers who elastic demand for the goods sold by the monopolist.

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3. Importance in the international trade – The concept of elasticity of demand is also important in the field of international trade. It is of great importance in determining the terms of trade (the rate at which the exports and imports are exchanged) and consequently gains from international trade, in determining the impacts of export and import and thereby on the balance of payment.

4. Incidence of taxation – Incidence of taxes refers to the persons who ultimately bear the burden of taxes, i.e., the person who ultimately pay the taxes. Whether the incidence of taxes is on the buyers or the sellers depends on the elasticity of demand. Higher is the elasticity of demand, more is the incidence of taxes on sellers. On the other hand, more inelastic is the demand, more is the burden on the buyers of the commodities.

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5. Case Study: Health Clubs

Elasticity of Demand for Health ClubsThe health club market provides an interesting case study in using the concepts of price elasticity of demand and income elasticity of demand

Price Elasticity of Demand

Price elasticity of demand measures the responsiveness of demand to a change in the own price of a good or service. When demand is inelastic (e.g. demand curve D1 in the diagram above), consumer demand is relatively insensitive to changes in price.

Elasticity tends to be low when the product is viewed by the consumer as a necessity, or when it takes up a small percentage of total income. Elasticity is low when there are few close substitutes and when the consumer has developed a strong sense of brand loyalty.

A relatively elastic demand curve is shown by D2 in the same diagram.

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What of the price elasticity of demand for health club memberships?

Regular gym users regard their health club visits as an important feature of their weekly exercise regime. They are unlikely to cancel a membership if fees rise from time to time. The majority of gym members pay their subscriptions using direct debit. They may take some time to realize that their monthly charge has changed. And, for most consumers, having made the decision to commit themselves to a membership of between $25-$50 per month, a small rise in fees is unlikely to lead to a cancelled membership.

Some towns and cities are well served by health clubs in both the premium and economy segments of the market. When there is genuine market competition, price elasticity of demand should be higher.

Income Elasticity of Demand

Income elasticity measures the responsiveness of demand to a change in consumers' real income. Although some fitness fanatics may regard their membership as a necessity (giving a low but positive value for income elasticity), for many consumers, an individual or family membership is often seen as a luxury item in their annual budget.

Normal luxury products have a highly positive income elasticity of demand. When the economy is strong, and incomes and employment are rising, we expect to see strong growth in market demand for health and fitness activities. This encompasses health clubs together with other activities (including sports-based holidays).

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