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Elasticity of Demand
Elasticity means the measurement of responsiveness
of one variable to other variable.
X =f (Y), X = dependent variable, Y = Independent
variable (If Y change ho it is going to affect
for X ! elasticity measure it)
"n elasticity of demand = (# change in thedemand for good ")$# change in an
independent variable
%ain Demand Elasticities
&rice elasticity of demand
'ross price elasticity of demand
Income elasticity of demand
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ther Elasticities
upply elasticity
"dvertising and cross
advertising elasticity
'on*ectural price elasticity
Imports and e+ports elasticities
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&rice elasticity of demand (the percentage change in
the uantity of a good demanded divided by the
corresponding percentage change in its price. -his is
related ith the movement along the demand curve)
&oint elasticity = "# = "$ = " X &
"& # "&$& " &
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Elasticity measure gives to pieces of information/
• It shos sign of the relationship beteenchanges in the relevant variables.
• It measures the e+tent to hich uantity
responds to a change in price.
0enerally price elasticity can be in three ranges/
1. &rice inelastic ( 2 ! 1), Ed 3 1
4. 5nitary (1), Ed = 1
6. &rice elastic (1 and infinity), Ed 7 1
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"rc elasticity allos you to calculate elasticity in to
price and to uantity combinations
Change in Q Q2-Q1 Average Q = (Q2+Q1)/2 = A Q . P2+P1
Change in P P2-P1 A P Q2+Q1
Average P (P2+P1)/2
Price
Quantity
demanded0Q1 Q2
P1
P2
A P
AQ
C
A
B
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Elasticity along a linear demand curve
Qd0
Ed = 00 : Perect e!a"tic
Ed # 1 : E!a"tic range
Ed = 1 : P$int $ unitary e!a"ticity
Ed % 1 : &ne!a"tic range
Ed = 0 : Perect ine!a"tic
P
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0raphical 8epresentation of Elasticity
1. 5nitary Elasticity
Qd
P2
P1
Q1 Q2 0
DP
D
5%
5%
P up 5% Qd 5%
down
P down 5% Qd 5%
up
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4. Inelastic situation
(relative)
P up 20% Qd 5%
down
P
P2
Q1 Q2
D
P1
0
D1
20%
5% DQd
Large range of price changes but
Small changes of quantity of eman
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6. Elastic situation
(relative)
P up 5% Qd 20%
Down
P
P2
Q1 Q2
D
P1
0
20%
5%
D
Qd
Small range of price changes but
massi"e changes of quantity of eman
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9. &erfect Inelastic situation
P
P3
Q1
P1
0
D
Qd
P2
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:. &erfect Elastic situation
P
P
Q1 Q2 0
D
Qd
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;actors affect for the price elasticity
$ime perio %more time lesser elasticity&
aicti"e nature for goo'ser"ices %more
aiction lesser elasticity&
a"ailability of substitutes an their quality
price range( an the necessity of the goos
share of income spent on goo
consumers ability to change his en"ironment
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Importance of price elasticity
• to etermine pricing policies'strategy
• to select inputs
• to select mar)ets
• to ma*imi+e re"enue
• to go"ernment ta*ation policies
;irm and the mar
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'ross elasticity of Demand
$his is relate 0ith the shift in eman cur"e t can beefine as the responsi"eness of eman for one prouct to
changes in prices of other prouct
* % change in quantity emane of goo &'% change
in price of &
Ep+ = "y . &+
"&+ &y
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Importance
to chec< the impact of prices of other goods to
the good concerned
to formulate a good pricing strategy
to analyse ris
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ature of 'ross &rice Elasticity
1) 'ross price elasticity for substitute goods
are positive
4) 'ross price elasticity for complement
goods are negative
6) 'ross price elasticity for independentgoods are >ero
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Cr$""-Price Ed = ' change in demand $r $n r$duct ' change in rice $ an$ther r$duct
omplements an Substitutes
Cr$"" Ed % 0 (-)*C$m!ement"
e.g.1. ,, demand ri"e" a"
rice $ ,, machine" dec!ine"e.g.2. ,emand $r !ight" t$
Canary &"!e" $ver 2 a!! a"
rice $ acc$mm$dati$n ri"e"
Cr$"" Ed # 0 (+)*u"titute"
e.g.1. i"e in rice $ etr$!
increa"e" demand $r u!ictran"$rt
e.g.2. 3a!! in rice $ m$i!e
h$ne" decrea"e" demand $r
!and !ine"
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E = AQ .
A Q
Income Elasticity of demand
4hi" mea"ure" the re"$n"ivene"" $ 5uantity demanded t$
change in inc$me6 h$!ding $ther act$r" are c$n"tant.
4hi" re!ated ith the "hit in demand curve due t$ change" in
inc$me.
3$r n$rma! g$$d" thi" i" $"itive and $r ineri$r g$$d" thi" i"
negative
&m$rtance (t$ chec7 uture demand6 deci"i$n" $ninve"tment6 $!icy deci"i$n" in internati$na! trade6 eect" $
change" in rea! inc$me)
E!a"ticity can e mea"ure $r $ther varia!e" "uch a"
adverti"ing and intere"t rate"6 etc.
Ey = % change in quantity demanded
% change in disposable Y
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Income and Elasticity ! 8elationship
Income Income
Elasticity 3 2
Income Elasticity = 2
Income Elasticity72
Demand 2
"
? " = ormal good, " ! Y = Inferior good
Y
d
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8elationship beteen -8, "8 and %8
-otal 8evenue = -8 = & .
"erage 9e"enue- $9': ; :': 9 ;
.arginal 9e"enue- %$9&'%:& .9
"ngel@s Aa
4he r$$rti$n" $ e8enditure $n a!! nece""itie" ($$d") dec!ine"
a" inc$me" ri"e and in c$ntra"t the r$$rti$nate e8enditure $n !
u8urie" (dura!e) $u!d increa"e. (thi" i" re!ated ith the c$n"um
er9" ahavi$ur ith inc$me increa"e")
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$he effect on re"enue of a price
change
at $int y6 Ed = 1
eteen 8 and y6 Ed # 1
eteen y and 6 Ed % 1
eteen 8 and y6 4increa"e" (i.e. ; i" +ve)
at y 4 i" at it" ma8imum(i.e. ; = 0)
eteen y and 6 4decrea"e" (i.e. ; i" -ve)
quantity
p r i c e
( £ )
quantity
t o t a l r e v e n u e
( £ )0
0
MR
AR
x
y p*
z
q*
lastic 9ange
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ncome lasticity / *amples %Loo)ing at this coefficient name 0hich
goo is =ormal an inferior&
?@)
change ine8enditure
(')
&nc$mee!a"ticity $
demand
1>?1 1>>1
Car" A $ther vehic!e" 7,754 10,657 3744 1!5
3urniture A 3!$$r c$vering" 4,031 4,"#3 !13" 07!
3$$d 30,!17 33,40# 1056 035
Beer ",561 ",!11 $40# $014
ther a!c$h$!ic drin7 6,363 7,616 1#6# 066
4$acc$ ",167 6,56# $1#57 $066C!$thing #,563 14,410 50!1 16"
3$$tear !,1#5 !,"#5 31"# 107
Energy r$duct" 17,31# !1,331 !316 07"
note &n the same pe'iod, 'eal national disposable income 'ose by !#"6%source : Pass & Lowes (1994)
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u!y E!a"ticity(his al)ays should go )ith lag &* p'ice changes it ta+es sometime to
'espond supply to p'ice changes in some secto's
Es = % change in quantity supplied% change in p'ice
s > 1(
lastic
s ? 1( nelastic
S
S
S
s 1(
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"dvertising Elasticity
measure of the effect of a change in a"ertising upon the
sales of a gi"en gooa % change in quantity emane of goo &'% change
in e*peniture on a"ertising goo &
f a >1- nelastic %large amount of e*peniture neee to
increase eman&f a?1- lastic %small amount of e*peniture neee to
increase eman&
'ross "dvertising Elasticity
measure of the responsi"eness of the quantity of eman
of one goo to a change in the e*peniture upon a"ertising
on another goo ;ositi"e for complements an negati"e for
substitutes
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'on*ectural &rice Elasticity
$his measures interepenence bet0een firms an
a goo measure to forecast price changes in
retaliation specially in oligopolistic mar)ets $his 0il
l help to firm@s pricing ecision ma)ing strategy
c %*pecte change in the price charge by
firm &'%ctual change in price charge by firm
&
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E+ports and Imports Elasticity
;rice elasticity of eman for e*ports % change in the
eman for e*ports in country *' change in price of e*ports in country &
ncome elasticity of eman for e*ports % change in
the eman for e*ports in country *' change in isposabl
e income abroa&
;rice elasticity of eman for imports % change in the
eman for imports in country *' change in price of impo
rts in country &
ncome elasticity of eman for imports % change in
the eman for imports in country *' change in isposab
le income aboar&
$hese elasticities are important to policy ecisions in
e*ternal trae an e"aluation
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Demand Estimation
Identification of firm@s real demand curve helps todetermine
the correct price,
inputs reuirements profit ma+imising output
Identification of demand
'onsumer intervies 'onsumer surveys 'onsumer clinics and focus groups %ar
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tatistical Estimation of Demand
8egression techniue (Identification ofvariables, obtain data on variables, euation
specification, estimation of regression
parameters, interpretation of regression
results/ coefficient of determination, ; and t
statistics, E, problems of regression/
"uto correlation, multi!collinearity,
heteroscedasticity).
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Demand ;orecasting %ethods• ,eterministic $ime Series nalysis %secular tren(
cyclical fluctuation( seasonal "ariation an ranominfluences&• $ren proAection( e*trapolation or cur"e fitting• arometric or lag or lea inicator methos• conometric moels %Single( multiple( lag( structural
moelBetc&• nputCoutput analysis %interrelationships&• Dpinion polling an sur"ey techniques %future plans&
$echniques selection epens on the forecastingistance( comple*ity of the forecasting problem( lea
time( accuracy( relationship( resources an time
a"ailability( etc
&rod ct Aife ' cle
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&roduct Aife 'ycle4hi" "h$" $ur "tage" $ demand $r a r$duct.
&ntr$ducti$n ha"e - demand increa"e" "!$!y.
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'haracteristics "pproach to Demand
-his says that consumers are demanded goods
because of their characteristics rather than consumers
on sa
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;ar7et egmentati$n
egmentati$n i" the r$ce"" $ "!icing a mar7et $r a articu!ar r$duct $r "ervice int$ a
numer $ dierent "egment". 4he "egment" are u"ua!!y a"ed $n act$r" "uch a"
dem$grahic"6 e!ie" $r the $cca"i$n $ u"e $ the r$duct.
;ar7et "egment" $r niche" are gr$u" $ c$n"umer" ith "imi!ar ta"te" and reerence
attern". ;a8imum numer $ mar7et "egment" i!! n$t e8ceed the numer $ $tentia!cu"t$mer".;ar7et can e "egmented acc$rding t$ r$duct characteri"tic"6 c$n"umer inc$me!eve!6 age and ge$grahic area. E!a"ticitie" can he! t$ identiy mar7et "egment".
egmentati$n can aid in: identiying c$metit$r"6 ne r$duct deve!$ment6
targeting adverti"ing e8enditure6 randing and e8!$iting mar7et niche".
4he internet r$mi"e" t$ r$vide ne $$rtunitie" $r "egmentati$n. &t $er"
c$ntinu$u" $$rtunitie" t$ cature in$rmati$n a$ut cu"t$mer ehavi$ur.
C$n"umer" identiy them"e!ve" and their characteri"tic" y their e!ectr$nic
articiati$n in articu!ar intere"t gr$u"6 and y their genera! $n!ine ehavi$ur.
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%ar
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Segmentation *ample 1 - eer
Beer 'ategory
9C#
:1#
Ales Lagers
• Which are the growing product
eg!ent through the "##0$• %n which product eg!ent are
&randing and advertiing !ot
i!portant$
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egmentation E+ample 4 / &aint
'pecialied
(aint
)ecorative paint %ndutrial paint
vera!! mar7et
Br$ad "ect$r"
;aH$r u"er" )% (ro+eional
)ecorator
,eneral
%ndutrial
Pr$duct gr$u (ri!er Matt ,lo 'pecial(urpoe etc-
Pr$duct !ine .aic )e /uxe 'uper de luxe
C$!$ur range White .lue Red etc-
Pac7aging an1&ruh Aerool 2ray1roller
,i"triuti$n $ut!et" Wholealer Retailer
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'riticism about demand theory
1& onsumers rationality is unpractical
2& ,eman not al0ays beha"e as it is state in
the la0
3& ;rice is not the main concern of consumer
$hey concern about quality( reliability( esign( afte
r sales ser"ices( bran names( recommenations
from friens( pre"ious e*perience( consumer guies( a"ertisements( etc
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1& Self CStuy
,eman stimation
1& Specify the eman function for the follo0ing
proucts2& Eo0 o you estimate mar)et eman for thefollo0ing prouctsF
1) a ne version of %icrosoft ffice
4) a ne brand of toothpaste6) internet ban< accounts
9) car e+haust systems
:) theatre performances
) a ne toll roadF) electricity supply
G) ri Aan
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uestions to discuss
E+plain mar
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8eferences
Chater I and J in ;c
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