3 B ELASTICITY OF DEMAND

PREPARED BY : REENA D ISAAC

 ELASTICITY OF DEMAND

• INTRODUCTION
• CONCEPT
• TYPES – INCOME ELASTICITY, CROSS ELASTICITY, PRICE ELASTICITY
• METHODS OF MEASURING PRICE ELASTICITY OF DEMAND
• FACTORS INFLUENCING ELASTICITY OF DEMAND
• IMPORTANCE
 Introduction
 The law of demand only explains the inverse relationship between
price of a commodity and its quantity demand.

 It does not explain the extent of change in the demand of a

commodity due to change in its price.

 The law of demand fails to explain quantitative relation between

price and demand.

 Therefore, Dr Alfred Marshall, explained the concept of elasticity of

demand to explain the extent of change in demand of a commodity
due to change in its price.
 Concept of Elasticity of Demand
Elasticity of demand is the degree of responsiveness or sensitiveness
of a commodity demanded to the given change in its price.

Alfred Marshall – “Elasticity of demand is great or small according

to the amount demanded which increases much or little for a given
fall in price, and quantity demanded, decreases much or little for a
given rise in price.”
Ed is a technical term which describes the responsiveness of change
in quantity demanded to fall or rise in its price.

P.A Samuelson – “Price elasticity is a concept of measuring how

much the quantity demanded responds to changing prices.”
 Types of Elasticity of Demand

Income Price Elasticity

Cross Elasticity
Elasticity

Positive ( Normal goods) Positive (Substitute goods) Perfectly Elastic

Negative ( Inferior goods) Negative (Complementary goods) Perfectly Inelastic
Zero ( Necessary goods) Zero (unrelated goods) Unit Elastic
Relatively Elastic
Relatively Inelastic
1. Income Elasticity
Income elasticity of demand may be defined as the percentage change in the
quantity demanded of a commodity in response to a given percentage
change in income and other factors including price remains unchanged.
Types of income Ed
1. Positive - Normal goods for which demand
increases with increase in income.
2. Negative - Inferior goods for which demand
decreases with increase in income of
consumer.
3. Zero – Necessary goods for which demand
remains constant with increase in income of
the consumer.
2. Cross Elasticity
Cross elasticity of demand can be defined as the percentage
change in quantity demanded of one commodity (say A) in
response to a given percentage in price of another commodity
Types of Cross Ed
(say B). 1. Positive – Substitute goods – tea &
coffee
2. Negative – Complementary goods –
tea & sugar
3. Zero – Unrelated goods – pen &
diamond
3. Price Elasticity
Alfred Marshall – “ Price elasticity of demand is a ratio of proportionate
change in the quantity demanded of a commodity to a given proportionate
change in its price.”

price
 Types of Price Ed
1. Perfectly elastic demand
The demand is said to be perfectly elastic when slight proportionate change in
price bring infinite (unlimited) proportionate change in quantity demanded.
The numerical value of perfectly elastic demand is
In such a case demand curve is a horizontal straight line or parallel to x axis
as shown in the figure.
2. Perfectly Inelastic Demand
When change in price has no effect on quantity demanded, then demand is
said to be perfectly inelastic. The numerical value of perfectly inelastic
demand is zero. In such case demand is a vertical straight line or parallel to
Y axis as shown in the figure.
It is seen that whether price rises to OP1 or
falls to OP2, demand remain the same. i.e
OQ. Ed=0
Eg salt , medicine, milk
3. Unitary Elastic demand
When change in price brings an exactly proportionate change in
quantity demanded, there is said to be unit elastic demand. Eg. If price
falls by 5% demand rises by 5% and vice versa. The numerical value of
unitary elastic demand is one.
When price falls from OP to OP1 demand
Rises from OQ to OQ1 in the same
proportion. In such case the demand curve
has a uniform slope and the demand curve is
called rectangular hyperbola. Ed=1
4. Relatively elastic demand
When change in price brings about more than proportionate change in
quantity demanded there is said to be relatively more elastic demand.
The numerical value of relatively elastic demand is great than one Ed>1.
Such a demand curve is a flatter curve. Eg. If the price of a commodity falls
by 25% its demand rises by 50%.
It can ne seen that when price falls from OP to
OP1 demand extends from OQ to OQ1 which is
relatively more in proportion to the change in
price
5. Relatively inelastic demand
When change in price brings about less than proportionate change in
Quantity demanded there is said to be relatively inelastic demand.
The numerical value of relatively inelastic demand is less than one.
Ed<1. Such demand curve is a steeper curve .Eg. If the price of a
commodity falls by 50% its demand rises only by 25%.
It can be seen that when price falls from OP to OP1
demand extends from OQ to OQ1 which is
relatively less in proportion to the change in price.
 Methods of Measuring Price Ed
1.Ratio/Percentage Method
 Developed by Prof. Alfred Marshall.
 In this method price elasticity is measured by dividing the percentage
change in the quantity demanded by percentage change in price.
2. Total Expenditure Method
 Developed by Prof. Alfred Marshall.

 Also called Total Revenue method.

 In this method the Ed is measured by comparing the change in the
total expenditure on a commodity in response to a change in the
price of a commodity.

 Total Expenditure = Price x Quantity demanded

 In this connection, Marshall has given the following propositions.
A] Relatively elastic demand (Ed>1)
When with a given change in the price of a commodity total outlay
increases, Ed is greater than one.

B] Unitary elastic demand (Ed=1)

When price falls or rises, total outlay does not change or remains
constant, Ed is equal to one.

C] Relatively inelastic demand (Ed<1)

When with a given change in price of a commodity total outlay
decreases, Ed is less than one.
This can be explained with the help of the following example.
Eg. ‘A’ original price is Rs 10 per unit and quantity demanded is 6 units. Total
expenditure is Rs 60.
As price rises to Rs 20 quantity demanded falls to 5 units and total expenditure
is Rs. 100.
In this case total outlay is greater than original expenditure. Hence Ed>1.
Eg ‘B’ original price is Rs.30 per unit and quantity demanded is 4 units.
Total expenditure is Rs. 120.
When price rises to Rs 40 per unit demand falls to 3 units. And total
expenditure incurred is Rs. 120. In this case total outlay is same to
original expenditure. Hence Ed=1

Eg ‘C’ original price is Rs.50 per unit and quantity demanded is 2 units
and total expenditure is Rs.100.
When price rises to Rs.60, quantity demanded falls to 1 unit and total
expenditure is Rs.60. In this case total outlay is less than original
expenditure. Hence Ed<1.
3. Point/Geometric Method
 Developed by Alfred Marshall.
 Ratio Method and total outlays methods are unable to measure Ed at
a given point on the demand curve.
 This method is used to find out the elasticity of demand at any given
point on a demand curve.
 Demand curve may be either linear or non linear.
 The formula is as follows
A] Linear Demand Curve
When the demand curve is linear i.e straight line, we extend the demand
curve to meet the Y axis at ‘A’ and X axis at ‘B’
Price Ed at ‘X’ axis is zero and ‘Y’ axis is infinite. Ed will be different at
each point.
Let us assume that AB is demand curve and its length is 8 cm. Point
elasticity at various points on a linear demand curve can be measured
as follows:

1] At point P, the point elasticity is measured as :

P= PB/PA=4/4=1
Thus, at point P, Ed=1

2] At point P1, the point elasticity is measured as :

P1=P1B/P1A=2/6=0.33
Thus, at point P1, demand is relatively inelastic Ed<1
3] At point P2, the point elasticity is measured as :
P2=P2B/P2A=6/2=3
Thus, at point P2 demand is relatively elastic Ed>1

4] At point A, the point elasticity is because upper segment is zero.

[perfectly elastic demand]

5] At point B, the point elasticity is zero because lower segment is zero

[perfectly inelastic demand]
B] Non-linear demand curve
When the demand is non-linear i.e convex to origin, to measure price
elasticity of demand we have to draw a tangent ‘AB’ touching the
given point on the demand curve and extending it to ‘Y’ axis at point
‘A’ and ‘X’ axis at point ‘B’
 Factors influencing the Ed
1. Nature of commodity
Demand for necessaries like food grains, medicines, etc relatively
inelastic. For comforts and luxury goods like cars, perfumes, furniture is
relatively elastic.
2. Availability of Substitutes
The commodities having many substitutes in the market have relatively
elastic demand. Eg soaps, shampoo, biscuits etc.
On the other hand salt has no substitute therefore has inelastic demand.
3. Number of uses
The commodities having many uses have relatively elastic demand.
When its price falls it can be put into many uses. Eg electricity.
4. Habits
If an individual becomes habituated to use certain commodity,
then the demand becomes inelastic. Eg cigarette.

5. Durability
Demand for durable goods such as table, fans etc is elastic,
whereas demand for perishable goods such as flowers, fruits is
inelastic.

6. Complementary goods
By and large, demand for complementary goods is relatively
inelastic. Eg car and petrol.
7. Income of the consumer
Change in price do not affect the demand of rich people. Thus people
who have high level of income have relatively inelastic demand. The
demand of poor changes according to changes in price, thus it is
relatively elastic.

8. Urgency & postponement

If the use of commodity is urgent, the demand is relatively inelastic. Eg
Medicines. On the other hand, if the use of commodity can be
postponed demand will be relatively elastic

9. Time period
Longer the duration of period greater will be the elasticity of
demand and vice versa. As the consumer can change the
consumption habits in the long run with cheaper substitutes.
Importance of Elasticity of demand
1. To the producer
Producer decides the price of his product to sell it in market. If the demand for
his product is relatively inelastic, he will fix a higher price and vice versa. The
of Ed is useful to monopolist to practice price discrimination.

2. To the Government
Taxation policy of the government is based on the concept of Ed.
Those commodities whose demand is relatively inelastic will be taxed more
because it will not affect their demand.

3. In Factor pricing.
Concept of Ed is useful to trade unions. They can successfully bargain for higher
wages if they produce commodities whose demand is relatively inelastic.
4. Importance in Foreign Trade
The countries exporting commodities for which demand is relatively
inelastic can raise their prices. Eg OPEC

5. Public Utilities
In case of public utilities like railways which have an inelastic
demand, government can either subsidise or nationalize them to
avoid consumers exploitation.

6. Proportion of expenditure
If the proportion of expenditure in a persons income is small, then
demand for the product is relatively inelastic. Eg News papers.
Additional Questions.
Distinguish between
1. Necessary goods and Prestigious goods.

Agree/ Disagree. Give Reasons.

1.Total outlay method is one of the methods of measuring Ed.
2. Various factors influence Ed.
3. Demand for necessaries is inelastic.
4. Demand for the commodity have multiple uses has elastic demand.