TYPES OF ELASTICITY OF DEMAND• 1) PRICE ELASTICITY OF DEMAND• 2) CROSS ELASTICITY OF DEMAND• 3) INCOME ELASTICITY OF DEMAND • 4) ADVERTISING OR PROMOTIONAL

ELASTICITY OF DEMAND

CROSS ELASTICITY OF DEMAND

It is the relationship between % change in the quantity demanded of a good to the % change in the price of a related good.

Eba= % Change in Quantity of X% Change in Price of Y

Where,Qx=Quantity of good X, Py = Price of good Y and delta = change. The Elasiticity of Demand for good X may be positve, negative or zero which depends on the nature of relation (may be as substitutes, complementary or unrelated )between the goods X and Y.

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1.SUBSTITUTE GOODS

If X and Y are substitute goods, a fall in the price of good Y will reduce the quantity demanded of good X. Similarly, an increase in the price of good Y will raise the demand for good X. Their cross elasticity is Positive.

Quantity of good X(TEA) is taken on X-axis and the quantity of good Y(COFFEE)is plotted on Y-axis .When the price of Y (COFFEE) increases from OY to OY1, the quantity demanded of X (TEA) rises from OX to OX1 . Demand curve shows POSITIVE elasticity of both the goods.

2.COMPLEMENTARY GOODS

If two goods are jointly demanded, rise in the price of one leads to a fall in the demand for the other. Rise in he prices of cars will bring a fall in their demand together with the demand for petrol. A fall in the prices of cars will raise the demand for petrol . Cross elasticity of demand is NEGATIVE.

The rise in the price of Y (CARS) from OY to OY1 , the demand for X (PETROL) falls from OX to OX1 . Demand shows NEGATIVE cross elasticity.

3. UNRELATED GOODS

If the two goods are unrelated, a fall in the price of good Y(SALT) has no effect whatsoever on the demand for good X(CAR). In such case , the cross elasticity of demand is ZERO.

A fall in the price of Y (SALT) has no effect on the quantity demanded of X(CAR).Even an increase in the price of good Y(SALT) from OY to OY1, the demand for good X(CAR) remains the same . Cross elasticity of demand is ZERO.

APPLICATIONS OF CROSS ELASTICITY IN MANAGEMENT

1.PRODUCTION

2.DEMAND FORECASTING AND PRICING

3.INTERNATIONL TRADE AND BALANCE OF PAYMENTS

INCOME ELASTICITY OF DEMAND

The concept of income elasticity of demand expresses the responsiveness of a consumer’s demand for any good to the change in his income.

Ey= % Change in Quantity Demanded % change in income

Where Delta is change, Q quantity demanded & Y is income. Q

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INCOME ELASTICITY OF DEMAND

If an increase in income leads to an increased demand for a commodity ,income elasticity is POSITIVE – also called NORMAL goods.

More is purchased as the income increases.

If an increase in income leads to a fall in the demand for a commodity , income elasticity is NEGATIVE - also called INFERIOR goods.

Less is purchased as the income increases.

NORMAL GOODS ARE OF 3 TYPES – NECESSARIES ,LUXURIES & COMFORTS

In case of LUXURIES, the coefficient of income elasticity is POSITIVE but high, Ey > 1. Assuming prices of all other goods as constant, if the income of the consumer increases by 5% & as a result his purchases of the commodity increase by 10% .Ey =10/5= 2(>1) INCOME DEMAND IS ELASTIC

NECESSITIES

The coefficient of income elasticity is positive but LOW, Ey <1.If the proportion of income spent on a commodity increases by 2% when the consumer’s income goes up by 5%, Ey =2/5= 0.4(<1) INCOME DEMAND IS INELASTIC

COMFORTS

The coefficient of income elasticity is unity Ey= 1 A 5% increase in income leads to 5% rise in demand, Ey =5/5= 1

INFERIOR GOODS The coefficient of income elasticity of demand in case of inferior goods is NEGATIVE. In this case , the consumer will reduce his purchases of it, when his income increases. If a 5% increase in income leads to 2% reduction in demand, Ey = -2/5 = -0.4(<0).

ZERO ELASTICITYIf with an increase in income , the quantity demanded remains unchanged, the coefficient of income elasticity, Ey =0.If with ,5% increase in income, there is no change in the quantity demanded, then Ey =0/5= 0

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ENGEL CURVE

Engel curve shows the quantities of a commodity which a consumer would buy at various levels of income . It expresses the income- quantity relationship.

IN CASE OF LUXURY GOODS

LA is tangent to the Engel curve E1 at point A. The coefficient of income elasticity at point A is

The curve E1 is income elastic over much of its range.

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IN CASE OF NECESSITY

NB is tangent to the ENGEL curve E2 at point B.The coefficient of income elasticity at point B is

The curve E2 is larger than zero but smaller than 1Income is inelastic.

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IN CASE OF INFERIOR GOOD

Engel curve E3 is backward sloping after point B. The coefficient of income elasticity at point C is

E3 is negatively sloped and the commodity is an inferior good.

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DETERMINANTS OF INCOME ELASTICITY OF DEMAND1.Nature of commodity: Commodities are grouped in to necessities,

comforts & luxuries.

2.Income level: Depends upon the income of the country.

3.Time period: Over a long run a luxury may become a necessity.

4.Demonstration effect: Changing tastes, preferences & choices of people.

5.Frequency: Higher frequency ,income elasticity will be high.

USE OF INCOME ELASTICITY IN BUSINESS DECISIONS

1.Planning of the firm’s growth: The knowledge of income elasticity of demand is

important for both the firms & govt.

2.Formulation of farm policy: The govt. of India has considered it necessary to

continue & increase various agricultural subsidies.

3.Forecasting demands: Used in forecasting future demand provided the firm

knows the growth rate of income & income elasticity of demand for the good

4.Formulating marketing strategies: The income elasticity of demand of potential buyer

class for products affects the no. ,nature & location of sales centres ,& the policies related to other sales promotion activities.

ADVERTISING ELASTICITY OF DEMAND

Advertising elasticity of demand is the measure of the rate of change in demand due to changes in advertising expenditure.

The amount of change in demand of goods due to advertisement is known as advertising elasticity of demand

ADVERTISING ELASTICITY OF DEMAND

Q= quantity sold of good X , A = units of advertising expenses on good X, Delta Q = change in quantity sold of good X, Delta A= change in advertising expenses on good X

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FACTORS INFLUENCING ADVERTISING ELASTICITY OF DEMAND

1.Stage of product’s development 2.Degree of competition 3.Effects of advertising in terms of

time 4.Effect of advertising by rival

firms

THANK YOU

A Nikhil Soares Presentation