Industrial EconomicsBY NISHANT KUMAR

Elasticity of Demand and Supply

Elasticity of Demand and SupplyElasticity of the demand is defined as the ratio of the percentage change in the quantitydemanded to the percentage change in the demand determinant under consideration.

It is a tool for measuring the responsiveness of one variable to changes in another, causativevariable. Elasticity has the advantage of being a unit less ratio, independent of the type ofquantities being varied.

Types of ElasticityPrice Elasticity of demand

Income Elasticity of demand

Cross Elasticity of demand

Promotional elasticity of demand

Expectations elasticity of demand

Price Elasticity of DemandIt is the ratio of relative change in a dependent variable(quantity demanded) to the relative change in an independent variable(Price).

Or it is a relative change in quantity demanded to a relative change in price.

ep= Relative change in quantity demanded

Relative change in price

ep= Percentage change in quantity demanded

Percentage change in price

ep= ΔQ . P

Q ΔP

Q: Quantity P: Price ΔQ/Q: Relative Change in Quantity Demanded

ΔP/P: Relative change in Price

Determinants of Price Elasticity of demand

• Availability of Substitutes

• Nature of Commodity

• Position of Commodity in the buyer’s budget

• Time Period

• Number of uses of a commodity

• Percentage of Income

• Brand Loyalty

Income Elasticity of DemandThe responsiveness of quantity demanded to changes in income is called income elasticity of demand.

ep= Relative change in quantity demandedRelative change in income

ep= Percentage change in quantity demandedPercentage change in income

ep= ΔQ / Y = Y . ΔQQ ΔY Q ΔY

The degree of income elasticity varies in accordance with the nature of commodities.

• In case of all normal goods, the income elasticity is positive.

• For essential goods, the income elasticity is less than one

The quantity demanded increases less than proportionately as income increases. Soap, salt, newspaper have low income elasticity of demand.

• For goods of comfort, the income coefficient is equal to unit which results in proportionate change in quantity demand.

• Luxury goods have income elasticity greater than unity implying more than proportionate change in quantity demanded.

Jewelry, automobiles are of this category.

Cross Elasticity of DemandDemand is also influenced by the prices of other goods and services.

The cross elasticity measures the responsiveness of quantity demanded to changes in price ofother goods and services.

Cross elasticity is used to classify the relationship between goods.

Example – Razor and its blades, cars.

The closer to commodities are substitute for each other.

Promotional Elasticity of DemandThe advertisement expenditure helps in promoting sales.

The impact of advertisement on sales is not uniform at all level in total sales.

An advertisement elasticity could be defined as the percentage change in quantity demanded for a percentage change in advertisements.

Determinants

1. The level of sales

2. Competitive Advertisements

3. Cumulative effect of past advertisements.

Elasticity of Price ExpectationsThe elasticity of price expectations may be defined as the ratio of the relative change inexpected future prices to the relative change in current prices.

Importance of the concept of elasticity1. Monopoly Price

2. Taxation

3. Joint Products

4. Increasing Returns

5. Wages

6. Price Determination.

Demand Forecasting

What is demand forecasting ?It is the process of determining what product are needed where, when and in what quantities.

It is the estimation of demand for the good in question in the forecast period.

It is the activity of estimating the quantity of a product or service that consumers will purchase.Demand forecasting involves techniques including both informal methods, such as educatedguesses, and quantitative methods, such as the use of historical sales data or current data fromtest markets.

It is also the foundation of a company’s entire logistics process. It supports other planningactivities such as• capacity planning

• master production scheduling (MPS),

• inventory planning

• overall business planning.

Benefits of Effective Demand Forecasting

•Improved customer service levels

• Fewer backorders and lost sales

• Less inventory investment in safety stock

• Improved production planning processes

• Earlier recognition of market place trends

Process of Demand Forecasting1. Identification of objective

2. Nature of goods

3. Appropriate technique of forecasting

The objective of forecasting, type of data available, the period for which the forecast is to be made, etc. aid in selecting appropriate technique of forecasting.

4. Interpretation of result

Efficiency of a forecast depends, to a large extent, upon the efficiency in the interpretation of its results.

Demand Forecasting Techniques Survey MethodsConsumer’s Survey

Experts opinion

Survey of Managerial Plans

Opinion Poll Methods

Statistical Methods

Types of Competition

PerfectCompetition

ImperfectCompetition

Monopoly

MonopolisticCompetition

Oligopoly

Perfect CompetitionThis is an economic situation that really doesn't exist, in which a bunch of conditions are met, not

the least of which are free entry and exit from a market, tons of sellers selling the exact same

product, and tons of buyers for that product who have perfect knowledge of what it does and

how it works.

An Indian fish market might be an example of something close to this (though real "perfect

competition" doesn't really exist.)

Characteristics• Larger number of sellers and buyers.

• Product homogeneity

• Free entry and exit of firms

•Profit Maximization

•No government regulation

• Perfect mobility of factors of production

• Perfect knowledge

MonopolyIt is market situation in which there is single seller, with no close substitute for the commodity it produces.

A market dominated by one seller. The cable company is an example of this in India (sort of like it is in America.) The cable company in India, facing no competition, is notorious for poor quality and poor service.

Processor Company: Intel

Salient features:

• A single firm produces and sells a particular commodity or a service.

• There are no direct competitors of the firm.

• No other seller can enter the market for whatever reasons legal, technical or economic.

• Monopolist is a price maker. He tries to take the best of demand and cost condition without the fear of new firms entering to compete away his profits.

Types of monopoly• Control over key raw material

• Patent, Copy Rights and Licenses

• Efficiency – Natural monopoly (Petrol, gasoline, water) generally government takes over these productions.

• Limit price policy

• Fiscal Monopoly – Printing of currency. Such monopoly is done by government itself.

Monopolistic CompetitionIt is found in the industry where there is large number of small sellers selling differentiated butclose substitute products.

Here, there are lots of sellers selling similar products that don't differ a whole lot in terms ofcharacteristics or price. Think breakfast cereals. In India, an example of this is the bankingsystem. After financial sector reforms in 1992, the banking system in India has become muchmore competitive with lots more banks offering similar products at similar prices.

More Example : Network giants.

Features of Monopolistic Competition• Larger number of sellers

• Differentiated Product

• Free Entry

• Selling Costs

• Price policy of a firm

• Imperfect knowledge

• Non-price Competition

OligopolyAn Oligopoly is market situation where there are few sellers producing homogeneous ordifferentiated products mutually interdependent with respect to pricing and output policies.

A situation where there are only a few sellers in a particular economy who control a particularcommodity. They can, therefore, influence prices and affect the competition. In India, anexample of this would be mobile telephony - There are only a few operators, examples of whichare: Airtel, Idea, BSNL, Reliance.

The action of each firm do affect the other sellers in the market. Price cutting by one firm willreduce the share of other firms.

Characteristics of Oligopoly Small number of sellers

In determined demand curves – demand curve depends on the reaction of the rivals actions.

Interdependent

Price rigidity and Non-price competition – compete in change in design and features. In such scenarios firms gives concession in various ways but very rigid to the price.

Existence of non-profit motives. Sales maximization with profit constraints

Maximization of joint profits rather than individual profits

Fair rate of profit and log-run stability.

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