Elasticity of Demand

Presentation by S.VINAY BHARGAV

D.SAI MOHAN KUMAR

“The concept of elasticity of demand and of cross-elasticity of demand are the essential heart of the meaning of the economic concept of demand.”

- CHESTER R. WASSON

“Elasticity of Demand is defined as the percentage change in quantity demanded caused by one percent change in the demand determinant under consideration.”

Ed

percentage change in quantity demanded of goods X

Percentage change in determinant Z=

There are two kinds of elasticity measurements. They are:

1.Point Elasticity

2. Arc Elasticity

It relates to the elasticity at a particular point on the demand curve.

FORMULA:

Q

Z

Z

QE=

Price P1

O Q Q1 Q2 Quantity Demanded

P2

Mid point of the chord

D

D

A

B

Types of Demand Elasticities

Price Elasticity of demandIncome Elasticity of demandCross Elasticity of demandPromotional Elasticity of demand Expectations Elasticity of demand.

Price Elasticity of Demand

“The measure of relative responsiveness of quantity demanded to price along a given demand curve is known as price elasticity of demand.”

E

Percentage change in quantity demanded of goods X

Percentage change in price of good X=

Q

P

P1

Q1E=

Types of Price Elasticity

1. Perfectly elastic demand

2. Absolutely inelastic demand

3. Unit elasticity of demand

4. Relatively elastic demand

5. Relatively inelastic demand

Price P

O Q Q1 Q2 Quantity Demanded

Price P1

O Q

Quantity Demanded

P

P2

Price

O Q1 Q2

Quantity Demanded

P2

P1

D

D

P

Q

Price

O Q1 Q2 Quantity Demanded

P1

P2

D

D

P

Q

Price

O Q1 Q2

Quantity Demanded

P2

P1

D

D

P

Q

Measurement of Price Elasticity of Demand

Elasticity of demand can be measured with the help of following four techniques:

1.Analytical Approach

2.Graphical Measure

3.Slope Measure

4.Total Outlay Method

Price

O Q1 Q2

Quantity Demanded

P2

P1

A

B

C

DE

Determinants of Price Elasticity of Demand

The number and closeness of the substitutes.The share of the commodity in buyers’ budget.Nature of the commodity.Number of uses a commodity can be put to.Habit forming characteristics.Time period.

Income Elasticity of Demand

Income elasticity of demand for a commodity shows the extent to which the consumer’s demand for the commodity changes as a result of a change in income.

Ey

Percentage change in quantity demanded of goods X

Percentage change in income of the consumer=

Q

Z

Z

QE=

Types of Income Elasticity of Demand

1. High Income Elasticity of Demand.

2. Unitary Income Elasticity of Demand.

3. Low Income Elasticity of Demand.

4. Zero Income Elasticity of Demand.

5. Negative Income Elasticity of Demand.

Price

O Q1 Q2 Quantity Demanded

P1

P2

D

D

P

Q

EY = 1

Price

O Q1 Q2 Quantity Demanded

P1

P2

D

D

P

Q

EY > 1

Price

O Q1 Q2 Quantity Demanded

P1

P2

D

D

P

Q

E< 10<

Price

O Q

Quantity Demanded

P2

P1

D

D

P E= 0

Price

O Q1 Q2

Quantity Demanded

P2

P1

D

D

P

Q

Use of the concept of Income Elasticity of Demand in Business

1.Planning of firm’s growth.

2.Forecasting demand.

3.Formulating marketing strategy.

Cross Elasticity of Demand Cross Elasticity of demand is defined as the ratio of

the percentage change in the demand for one good to the percentage in the price of some other related good.

Exy = Qx

Py

P1

Q1

Price of coffee

O Q1 Q2 Quantity of Tea

P1

P2

D

D

X

Y

O Q1 Q2

Quantity of butter

D

D

P1

P2

Price of Bread

X

Y

E XY

Proportionate change in quantity demanded for product X=

Proportionate change in price of product Y

Significance of cross elasticity of demand:

•Knowledge of cross Elasticity of demand helps a firm to estimate the likely effect of pricing decisions of its traders dealing in related products on sales

•Helps in defining industry

Advertising Elasticity of demand measures the response of quantity demand to change in expenditure on advertising and other sales promotional activities

E A

Proportionate change in sales

Proportionate change in Advertising expenditure=

EA = Q

A

A

Q

FORMULA:

Significance of Advertising elasticity of demand:

• The advertising agencies richly depend on this concept to provide consultancy for their clients about the advertisement budgets for a given level of sales activity.

Factors influencing Advertising Elasticity of Demand

1. Stage of product market.

2. Effect of advertising in terms of time.

3. Influence of advertising rivals.

Elasticity of price expectations may be defined as the ratio of the relative change in expected future prices to the relative change in current price.

E peProportionate change in expected future price

Proportionate change in current price=

Ep Cp

Cp Ep

E pe =

Significance of the Concept of Elasticity of Demand

1. Level of Output and Price.

2. Fixation of rewards for Factors of Production.

3. Government Policies.

4. Demand Forecasting.

Elasticities of Demand and managerial Decision Making

Factors that can be under control of the firm.price, advertising expenditure, quantity, quality

of product.

Factors that are beyond control of the firm.tastes, incomes of consumers, competitor’s

price