ELASTICITY OF DEMAND

ECONOMICS

Submitted by:
ADITYA AMAR
2014006
SEMESTER II

DAMODARAM SANJIVAYYA NATIONAL LAW UNIVERSITY

Visakhapatnam
March 2015

CERTIFICATE

Title of the subject: elasticity of demand

Name of the faculty: Prof. AbhishekSinha

Particulars

Date and signature of the

faculty

Remarks

Abstract
First consultation
Second consultation
Third consultation and final
submission

I, Aditya Amar, hereby declare that this Project titled elasticity of demand by me is an
original work undertaken by me. I have duly acknowledged all the sources from which
the ideas and extracts have been taken. The projects free from any plagiarism issue.

(Signature of the candidate)

Place: Visakhapatnam

Name: Aditya Amar

Date: 1/03/2015

Roll No. 2014006

Semester II

TABLE OF CONTENT
TITTLE

PAGE NO.

CERTIFICATE

ACKNOWLEDGMENT

ABSTRACT

INTRODUCTION

Meaning and definition of elasticity of demand

Importance of concept of elasticity

Factors influencing price elasticity of demand

Degrees of elasticity

Measurement of elasticity

Reason for decline in demand

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10
14
17
18

Determinants of Demand
CONCLUSION

21

BIBLIOGRAPHY

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ACKNOWLEDGEMENT
I have endeavored to attempt this project. However, it would not have been feasible
without the valuable support and guidance of Prof. AbhishekSinha. I would like to extend
my sincere thanks to him.
I am also highly indebted to Damodaram Sanjivayya National Law University Library
Staff, for their patient co-operation as well as for providing necessary information & also
for their support in completing this project.
My thanks and appreciations also go to my classmates who gave their valuable insight
and help in developing this project.

ELASTICITY OF DEMAND
ABSTRACT
Aim and Objective
The aim of the project is to present a detailed study of the topic Elasticity of Demand
(types and measurement)through, suggestions, different writings and articles.
Research Plan
Doctrinal method has been followed.
Type of Study
Descriptive and analytical
Scope and limitations
Though the topic Elasticity of Demand (types and measurement) is an immense
project and pages can be written over the topic but because of certain restrictions and
limitations I was not able to deal with the topic in great detail.
Source of Data
The following secondary sources of data have been used in the project:

Articles/Journals/Law Reports

Books

Websites

INTRODUCTION
Demand is desire backed by willingness to pay and ability to pay i.e. a wish to have a
commodity does not become demand. A person wishing to have a commodity should be
willing to pay for it and should have ability to pay for it. Thus a desire becomes demand
if it is backed by willingness to pay and ability to pay. Demand is meaningless unless it is
stated with reference to a price.

Decisions regarding what to produce, how to produce and for whom to produce are taken
on the basis of price signals coming from the market. The law of demand explains inverse
relationship between price and quantity demanded. When price falls quantity demanded
of that commodity will increase. The deficiency of law of demand is removed by the
concept of elasticity of demand.
MEANING AND DEFINITION OF ELASTICITY OF DEMAND
The term elasticity was developed by Alfred Marshall, and is used to measure the
relationship between price and quantity demanded. The law states that the price of a
commodity falls, the quantity demanded of that commodity will increase, i.e. it explains
only the direction of change in demand and not the extent of change. This deficiency is
removed by the concept of elasticity of demand.
Elasticity means responsiveness. Elasticity of demand refers to the responsiveness of
quantity demanded of a commodity to change in its price.
According to E.K. Estham, elasticity of demand is a measure of the responsiveness of
quantity demanded to a change in price.
IMPORTANCE OF THE CONCEPT ELASTICITY
The concept of elasticity of demand plays a crucial role in business-decisions regarding
fixing of price with a view to make larger profit. For instance, cost of production is
increasing the firm would want to pass the rising cost on to the consumer by raising the
price. Firms may decide to change the price even without any change in the cost of
production. But whether raising price following the rise in cost or otherwise proves
beneficial depends on:
a)

The price elasticity of demand for the product, i.e. how high or low is the

proportionate change in its demand in response to a certain percentage change in its price.
b)

Price elasticity of demand for its substitutes, because when the price of a product

increases the demand for its substitutes increases automatically even if their prices remain
unchanged.
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Raising the price will be beneficial only if:

a)

Demand for a product is less elastic

b)

Demand for its substitutes is much less elastic.

Elasticity of demand establishes the quantitative relationship between quantity demanded

and price or other demand determinants.
TYPES OF ELASTICITY
These are three types of elasticity:1.

Price elasticity

2.

Incomeelasticity

3.

a.

Zeroincome elasticity

b.

Negative incomeelasticity

c.

Positive income elasticity

Cross elasticity

1. Price ElasticityPrice elasticity of demand may be defined as the degree of responsiveness of quantity
demanded of a commodity in response to change in its price i.e. it measures how much a
change in price of a good affects demand for that good, all other factors remaining
constant. It is calculated by dividing the proportionate change in quantity demanded by
the proportionate change in price.
EP=

Proportionate change in quantity demanded

Proportionate change in price

2. Income elasticity-

Income elasticity of demand measures how much a change in income affects demand for
that commodity if the price and other factors remain constant.
A product with an income elasticity of more than one will experience a growth in demand
that is higher than growth in consumers income. Luxury goods tend to have relatively
high income elasticity. Low quality goods have negative income elasticity, as people stop
buying them when they can afford to.
Ed=

Proportionate change in quantity demanded

Proportionate change in income

There are three types of income elasticity

Zero income elasticity Here a change in income will have no effect of quantity
demanded. For example: - salt, matches, cigarettes.
Negative income elasticity Here an increase in income leads to a decrease in quantity
demanded. This happens in inferior goods.
Positive income elasticity In this an increase in income will leads to an increase in
quantity demanded. For most goods income elasticity is positive.
3. Cross elasticity
This measures the change in demand for a commodity due to change in price of another
commodity.
ED= Percentage change in quantity demanded of commodity A
Percentage change in price of commodity B
If the goods having substitutes the cross elasticity is positive i.e. an increase in the price
of X will result in an increase in sales of Y. If the goods are complementary and increase
in the price of one commodity will depress the demand for the other. So cross elasticity
will be negative. If the goods are unrelated cross elasticity will be zero. Because however

much the price of one commodity increased demand for the other will not be affected by
that increase.
FACTORS INFLUENCING PRICE ELASTICITY OF DEMAND
1. Nature of commodity
Elasticity depends on whether the commodity is a necessity, comfort or luxury.
Necessities of life have inelastic demand and comforts and luxuries have elastic demand.
2. Availability of substitutes
Goods with substitutes have elastic demand and goods without substitutes have inelastic
demand. For example: coffee and tea are substitutes. If price of tea increases, people may
switch over to coffee. If price of coffee raises people may shift to tea. The demand of salt
is inelastic.
3. Uses of the commodity
Certain goods can be put to many uses. Example electricity. Such goods have elastic
demand because as the price decreases, they will be put to more uses.
4. Proportion of income spent on commodity
For some goods, consumers spend only a small part of their income. The demand will be
inelastic. For eg: - salt and matches
5. Price of goods
Generally cheap goods have inelastic demand and expensive goods have elastic demand.
6. Income of consumers
Very rich people have inelastic demand for goods and poor people have elastic demand.
Because rich people will buy the commodity at all levels of prices where poor people
there is a change in quantity of consumption according to change in price.
7. Time period
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Elasticity would be more in the long run than in the short run. Because in the long run
consumers can adjust their demand by switching over to cheaper substitutes. Production
of cheaper substitutes is possible only in the long run.
8. Distribution of income and wealth in the society
If there is unequal distribution of income, the demand of commodities will be relatively
inelastic. If the distribution of income and wealth in the society is equal there will be
elastic demand for commodities.
DEGREES OF ELASTICITY
Since the responsiveness of quantity demanded varies from commodity to commodity
and from market to market, it is important to study the degrees of price elasticity. We can
identify five degrees of elasticity. They are: 1.

Perfectly elastic demand

2.

Perfectly inelastic demand

3.

Unitary elastic demand

4.

Relatively elastic demand

5.

Relatively inelastic demand

1. Perfectly elastic demand

Perfectly elastic demand is the situation where a small change in price causes a
substantial change in quantity demanded i.e. a slight decline in price causes an infinite
increase in quantity demanded and a slight increase in price leads to demand contracting
to zero. The demand is hypersensitive and the elasticity of demand is infinite. Demand
curve becomes a horizontal straight line parallel to x-axis

10

Price

ep =
2

Qty demanded
2. Perfectly inelastic demand It is the situation wherechanges in price cause no change
in quantity demanded. Quantity demanded is non-responsive or inelastic. Demand curve
is a vertical line parallel to Y-axis and the elasticity of demand is zero.

P1

Price

ep =
0
P

Quantity demanded

P2

It is clear that the price is OP or OP1 or OP2. The quantity demanded remains
unchanged at OM.

3. Unitary elastic demand

It refers to that situation where a given proportionate change in price is accompanied by
an equally proportionate change in quantity demanded. For example, if price changes by
10%, quantity demanded also changes by 10%.

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ie; elasticity will be equal to one. The demand curve is a rectangular hyperbola.
Y

Price

ep =1

P1

Quantity demanded

N1

4. Relatively elastic demand

Demand is said to be relatively elastic when a given proportionate change in Price
causes a more than proportionate change in quantity demanded
Y

Price

ep>1
D

P1

0
N

5. Relatively Inelastic demand

12

N1

Demand is relatively inelastic when a given proportionate change in price causes a less
than proportionate change in quantity demanded. Demand curve will be a very steep
curve. Elasticity is less than 1. For example, If price changes by 20% quantity demanded
changes by 10%
Then ep = 10/20 = .5

ie;

ep<1
D

Price

P1

ep =1

N1

Of the five degrees of elasticity perfectly elastic and perfectly inelastic are extreme cases
i.e. rarely found in actual life. Unitary elasticity, relatively elastic and relatively inelastic
demand are the most widely used price elasticties.

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MEASUREMENT OF ELASTICITY OF DEMAND

Important methods to measure the elasticity of demand are:
1. Proportional or percentage method
2. Expenditure or Outlay method
3. Geometric or point method
These are the commonly used methods.
1. Proportional method or Percentage method
Under this method the elasticity of demand is measured by the ratio between the
proportionate or percentage change in the quantity demanded and proportionate or
percentage change in price. It is also known as formula method.
For example: Percentage change in the quantity demanded /Percentage change in
price
Price of A

Quantity demanded of A

10

15

When price of A is Rs.5 quantity demanded is 10. When price falls to Rs.4
quantity demanded rises to 15.
Here p = 1,

q= 5

Initial price = 5,

Initial quantity = 10

Elasticity is greater than one (relatively elastic) if price elasticity is equal to one, it is
unitary elastic demand. If elasticity is less than one, it is relatively inelastic demand. If
elasticity is more than one, it is relatively elastic demand. If elasticity is zero, it is
perfectly inelastic demand. If elasticity is infinity, it is perfectly elastic demand.

2. Expenditure or Outlay method

By this method elasticity is measured by estimating the change in price that leads to a
change in quantity demanded causes changes in total expenditure incurred on commodity.
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According to sellers total expenditure means total revenue. So this method is also known
as total revenue method
Quantity

Total Expenditure

18

Demanded (Q)
3

(P x Q)
54

15

60

12

60

Price (P

e> 1
e=1
e

9
6
54
In this table a fall in price leads to a more than proportionate increase in quantity
demanded increase in total expenditure. Conversely, a fall in price leads to a less than
proportionate increase in quantity demanded results in decrease in total expenditure. A
fall in price leads to a proportionate increase in quantity demanded result in total
expenditure remaining constant
In this figure price is on the vertical axis and total expenditure on horizontal line. As the
price falls and total outlay increases, elasticity is greater than 1. We find elasticity greater
than 1 in the CB portion of the total outlay curve. In BA, total expenditure remains the
same while price is falling. Therefore elasticity is equal to 1. In AL the price is falling and
total expenditure is also falling. From A to L the curve is bending towards the origin. So
elasticity is less than one
If total expenditure increases, elasticity >1
If total expenditure decreases, elasticity<1
If total expenditure remains constant, elasticity=1
3. Geometric method or Point or Straight line method
This method is used to measure the change in quantity demanded in response to a very
small change in price. If demand curve is a straight line, elasticity at any point on the
straight line can be calculated using the point method.
When demand curve is a horizontal straight line parallel to x axis elasticity is equal to
infinity. It is perfectly elastic demand. When demand curve is a vertical straight line
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parallel to y axis elasticity is equal to zero. It is perfectly inelastic demand. For

calculating elasticity at any point on a downward slopping demand curve, we have to
extend the demand curve to touch the x axis and y axis.
Then the point at which elasticity is to be known has to be marked on demand curve
dividing it into upper segment and lower segment.
ep = lower segment\upper segment

Y
a

ep=2

PRICE

ep>1

ep=1

ep<1

Qty demanded

ep=0

REASON FOR DECLINE IN DEMAND

There are certain reasons for the sudden decline of demand for our commodity.
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1. Availability of cheap substitutes

The main reason is the availability of cheap substitutes in the market i.e. more substitutes
is available in the market at low price. So that people buy more of that commodity and
because the demand for our commodity falls. Substitution effect means change in demand
due to substituting one commodity for another. When price of a commodity falls the
cheaper commodities will be substituted in the place of dearer commodities. Thus price
of the commodity falls more of it will be demanded and the consumer uses it as a
substitute for high priced commodities.
2. Lack of Advertisement
Lack of Advertisement is also a reason for the declining demand for goods. In a highly
competitive market advertisement is very important and it also affect the change in
demand. The main objective of advertisement is to create additional demand by attracting
more consumers to our product. So we must advertise well to increase our demand of our
product.
3. Technological progress
Technological progress also affect demand for a commodity. Inventions and discoveries
bring new things in the market. So people will not demand older things. So we must use
more technological devices to improve the demand for our product.
4. Lack of demonstration
Lack of demonstration also brings out our commodity to a fall in demand i.e. people get
motivated or they were attracted by the demos given by us and they will buy that product
not because of their increase in income or it becomes a cheaper product but their
neighbour or relatives bought it. Tendency of the consumer to imitate others will help us
to increase the demand for our commodity.
5. Free goods
More Free goods are given by other producer to attract consumers and that will affect the
demand of our product. So we also gave more free goods than the other companies.
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Because of these reasons we must forced to reduce the price of our commodity to
increase our commodities demand. For this we must know the different market conditions
and the factors affecting demand for a commodity.
DETERMINANTS OF DEMAND
1.

Price of a commodity

Price of the commodity is the most important factor that determine demand. An increase
in price of a commodity leads to a reduction in demand and a decrease in price leads to an
increase in demand.
2. Price of related goods
Demand for a commodity depends on Price of related goods also. Related goods include
both substitutes and complementary goods.
Substitutes are those goods which can be used one another or the goods with same use are
substitutes. e.g.:- tea and coffee.
When price of tea falls demand for coffee also falls. Because when price of tea falls
people buy more tea and less coffee.
Complementary goods are those goods which can be used only jointly. e.g.: - car, petrol
or pen, ink. When price of a commodity raises demand for its complementary goods falls.
If x and y are complementary goods we cannot use x without y. When price of x raises
demand for x falls and y cannot be used without x and demand for y also falls.
3. Income of the consumer
Income of the consumer and demand for a commodity are positively related. For normal
goods when income increases demand also increases and vice versa. But for inferior
goods there is a negative relationship between income and demand. So when income
increases, demand decreases.
4. Taste and Preferences of consumers

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Taste and Preferences of consumers also brings out changes in demand for a commodity.
Tendency to imitate other fashions, advertisements etc affect demand for a commodity. It
change from person to person, place to place and time to time.
5. Rate of Interest
Higher will be demanded at lower rates of interest and lower will be demanded at higher
rate of interest.
6. Money supply
Demand is positively related to money supply. If the supply of money increases people
will have more purchasing power and hence the demand will increase and vice versa.
7. Business condition
Trade cycles or business cycles also demand for a commodity. Demand will be high
during boom period and low during depression.
8. Distribution of income
Distribution income in the society also affects the demand of commodity. If there is equal
distribution of income demand for necessary goods and comforts will be greater. If there
is an unequal distribution of income demand of comforts and luxuries will be greater.
9. Government policy
Government policy also affects the demand of commodities. For example, if heavy taxes
are imposed on certain goods, the demand will decrease. On the other hand, if
government announces tax concessions for certain commodities, their demand will
increase.
10. Consumers expectations
Consumers expectation about a further rise or fall in future price will affect the demand
of a commodity. If consumers expect a rise in the price of a commodity in the near future,
they may purchase large quantity even though there is some rise in the price. When the
price of a commodity decreases, people expect a further fall in price and postpone their
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purchase. Similarly, if consumers believe that their incomes will rise in the near future
they are more inclined to buy more expensive items today. So these expectations change
the demand for goods.

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CONCLUSION
In the project regarding the elasticity of demand, we discuss different degrees, types and
measurement of elasticity. Applying the theory of elasticity we have to increase our
demand of our commodity. But this increase in demand will not lead to an increase in
cost of production. When cost of production increases automatically we must sacrifice the
rate of profit that we earn. So we must take some strategic decisions to improve our
quality of our commodity and thereby increase profit, increase in demand and also we
have to reduce the cost of production.
Although most businessmen are very much aware of the elasticity of demand of the
goods they make, the use of precise estimates of elasticity of demand will add precision
to their business decision i.e. the theory of elasticity of demand is very useful at the time
of taking tactical decisions by the top management. So this project is much useful to us to
know how elasticity influences the working of business and even in our day to day life.

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BIBIOGRAPHY
BOOKS REFERRED:
SurbhiAroras Economics for Law students, 2ndedn, 2012, Central Law
Publication.
Dr. S.R.Mynanis General principal of Economics , 4 thedn, 2008, Allahabad Law
Agency.
R.C Agrawals economics of development and planning, 4 th revised edn, Lakshmi
NarainAgrawal.
K.C. Gopalkrishnas legal Economics, reprinted 2010, Eastern Book Company.
Dr. S.R. Mynanis general principals of economics for law students, 4 thedn 2008,
Allahabad Law Agency.
GauravDatt&AswaniMahajansdatt and Sundhram Indian Economy, 63rd revised
edn, S.Chand publication.

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