Elasticity of Demand

Presented By:Rishav Pandey(322)Priyanka Jain(319)Raman Verma(321)Rohit Gera(318)Rishabh Rawat(320)Priyabrat Dehury(324)Rahul Gusain(325)

Content• What is Elasticity of Demand• Degrees of Elasticity of Demand• Types of Elasticity of Demand

Price Elasticity of DemandCross Elasticity of DemandIncome Elasticity of Demand

• Method of calculating Elasticity of Demand• Factors affecting Elasticity of Demand• Uses of Elasticity of Demand• Case Study

What is Elasticity of Demand?• How sensitive the demand for a good is to the changes

in other economic variables, such as the prices and consumer income.

• ep = % change in quantity of a good demanded

% change in another economic variable

• A higher demand elasticity for a particular economic variable means that consumers are more responsive to changes in this variable, such as price or income.

Degrees of Elasticity of Demand

• Perfectly Elastic

• Unitary Elastic • Elasticity greater than 1

Degrees of Elasticity of Demand(cntd)

Degrees of Elasticity of Demand(cntd)

• Elasticity less than 1 • Perfectly inelastic

Types of Elasticity of Demand• Price Elasticity of Demand: A measure of the

relationship between a change in the quantity demanded

of a particular good and a change in its price.

• Cross Elasticity of Demand: It measures the

responsiveness of the quantity demanded for a good to

a change in the price of another good, ceteris paribus.

Types of Elasticity of Demand(cntd..)

• Income Elasticity of Demand: It measures the

responsiveness of the quantity demanded for a good

or service to a change in the income of the people

demanding the good, ceteris paribus.

Price Elasticity of Demand The price elasticity of demand (PED) is a measure that captures the responsiveness of a good's quantity demanded to a change in its price. More specifically, it is the percentage change in quantity demanded in response to a one percent change in price when all other determinants of demand are held constant.

FORMULA:PED = %Change in Quantity Demanded / %Change in Price

DEGREES OF PRICE ELASTICITY OF DEMAND

1. Perfectly Elastic Demand:

DEGREES OF PRICE ELASTICITY OF DEMAND(cntd...)

2. Perfectly Inelastic Demand:

3. Unitary Elastic Demand:

DEGREES OF PRICE ELASTICITY OF DEMAND(cntd...)

4. Relatively Elastic Demand:

5. Relatively Inelastic Demand:

FACTORS AFFECTING PRICE ELASTICITY OF DEMAND

• Nature of commodity• Availability of substitutes• Income level• Level of price• Postponement of consumption• Number of uses• Share in total expenditure• Time period• Habits

Income Elasticity of DemandTypes Of Income Elasticity Of Demand:Positive Income elasticity of demand

P

A

YD

D

B SOX

Quantity Demanded

Inco

me

Income Elasticity of Demand(cntd…) Negative Income Elasticity of Demand

Price

P

B

A

S

Total Revenue

Quantity Demanded (000s)

Income Elasticity of Demand(cntd…)

Zero Income Elasticity of Demand

X

Y

O D

D

Quantity Demanded

Inco

me Y’’

Y’

Y

Cross Elasticity of Demand

Methods of Calculating Elasticity of Demand

• Ratio (or Percentage) Method The most popular method used to measure elasticity. Elasticity of demand is expressed as the ratio of proportionate change

in quantity demanded and proportionate change in the price of the commodity.

It allows comparison of changes in two qualitatively different variables.

It helps in deciding how big a change in price or quantity is.

where Q1= original quantity demanded, Q2= new quantity demanded, P1= original price level, P2= new price level

Xcommodity of pricein change ateProportionXcommodity of demandedquantity in change ateProportion=ep

Methods of Calculating Elasticity of Demand

• Point Elasticity Method– Elasticity measured at a point of demand curve is

referred as point elasticity of demand.• For nonlinear demand curve we need to apply calculus to

calculate point elasticity. • As changes in price become smaller and approach zero, the ratio

becomes equivalent to the first order derivative of the demand function with respect to price

• Point elasticity can be expressed as:

ep = =PdPQdQ

//

dPdQ

QP.

Methods of Calculating Elasticity of Demand

• Arc Elasticity Method – Used when the available figures on price and quantity are

discrete, and it is possible to isolate and calculate the incremental changes.

– It is used to find the elasticity at the midpoint of an arc between any two points on a demand curve, by taking the average of the prices and quantities.

– This method finds wider applications, as it reflects a movement along a portion (arc) of a demand curve

ep = /

=

2/)( 21

12

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2/)( 21

12

PPPP

12

21

PPPP

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Methods of Calculating Elasticity of Demand• Total Outlay Method (Marshall)

– Elasticity is measured by comparing expenditure levels before and after any change in price, i.e. whether the new expenditure is more than, or less than, or equal to the initial expenditure level.

– Helps a seller in taking a decision to raise price only if:• Reduction in quantity demanded does not reduce total revenue or• Reduction in price increases the quantity demanded to the extent

that total revenue also increases.– Degrees

• When demand is elastic, a decrease in price will result in an increase in the revenue (sales).

• When demand is inelastic, a decrease in price will result in a decrease in the revenue (sales).

• When demand is unit-elastic, an increase (or a decrease) in price will not change the revenue (sales)

Factors Affecting Elasticity of Demand• Availability of substitutes

• Nature of product

• Share in total expenditure

• Postponement of consumption

• Number of uses

• Time period

• Income level of consumer

Uses of Elasticity of Demand

• Decision of Monopolist

• The Government

• Business Sector

• Input Price

• Rate of Exchange and Balance Payment

Case Study:• The health club market provides an interesting case

study in using the concepts of price elasticity of demand and income elasticity of demand.

• 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. 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.

Case Study(cntd…):• 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).

• In an economic slowdown, discretionary spending on health clubs may fall-although in the short term, thousands of members are committed to an annual fee.

Case Study(cntd…):

What is the price elasticity of demand for health club

memberships?

Thank You