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Saturday, 10 November 2018

Elasticity of Demand

This article about elasticity of demand includes following contents.

  • Elasticity of Demand
  • Price elasticity of demand
  • Measurement of Elasticity by percentage method
  • Types of price elasticity of demand
  • Flatter and steeper demand curve
  • Elasticity in absolute terms   
 Scroll down the page to read specific content.

Elasticity of Demand

The law of Demand does not indicate degree of change in demand due to change in price of a commodity. It only shows the direction i.e. demand decreases with increase in price and vice-versa but it is very important to know about degree of change for analyzing. Hence the concept of elasticity of demand is formulated in economics.
Due to changes in factors of demand other than own price of the commodity, degree of responsiveness of demand is known as elasticity of demand.
Let me clear you with an example. If price of related good changes by 2%, demand of the commodity changes by 3%, it means demand is changed 1.5 times. Such measurement is known as elasticity of demand.






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how to measure elsaticity of demand. method of measurement of elasticity of demand

 

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Price Elasticity of Demand



Here, we measure the degree of responsiveness of quantity demand of a commodity due to change in own price of the commodity. Such measurement is known as price elasticity of demand.
It shows the magnitude of change in quantity demanded as a result of change in price.

Measurement of Price Elasticity of Demand


We are measuring price elasticity of demand by percentage method or proportionate method.


Where,
Percentage change in quantity demanded = (Q1 –Q/P1 – P) *100
Q1 = Latter quantity (after change)
Q   = Initial Quantity
P1 = Latter Price
P    = Initial price

 Note- Minus (-) sign before the values is ignored in economics.


#Types/Degrees of Price Elasticity of Demand


Unitary Elastic Demand (Ed =1)


If percentage change in the quantity demanded is equal to percentage change in price, it is known as unitary elastic demand.

demand change is equal to change in price is called unitary elastic demand

More than unitary elastic (Elastic) Ed>1


If percentage change in the quantity demanded is greater than percentage change in price, it is known as elastic demand.

demand change more than change in price is called elastic demand

Less than unitary elastic demand (Inelastic) Ed<1


If percentage change in the quantity demanded is less than percentage change in price, it is known as inelastic demand.

demand change less than change in price is called inelastic demand

Perfectly Elastic Demand (Ed=∞)


In this case price remains constant but quantity demand changes. Demand curve is horizontal straight line parallel to X axis. Quantity Demand may increase or decrease with no limits.

demand changes to unlimited extent on constant price is called perfectly elastic demand

Perfectly Inelastic Demand ( Ed=0)


In this case even price changes but quantity demanded does not change. We get vertical demand curve parallel to Y axis in this type of elasticity.


Demand does not change with change in price is called perfectly inelastic demand




#Factors affecting Price Elasticity of Demand



Nature of Commodity




Elasticity of demand of a commodity depends upon its nature. If commodity is necessity for life, it is inelastic because human ignores price changes in case of necessities. Whatever the prices, he has to purchase these commodities.

In case of Luxury goods, demand is elastic. When price of luxury goods fall, people buy more and when price rises, people buy less substantially.


Availability of Substitute Goods



If substitute good is available, people shift quickly and change their demand easily. Hence it can be said that demand of such type of goods is elastic. If substitute goods are not available then people have to buy same good whatever the prices, hence demand in this case is inelastic.


Income Level




The goods have inelastic demand that are purchased by higher income person because such person ignores the price change and continues purchasing. Low income group has more elastic demand.


Habits



The demand for goods that are consumed habitually is inelastic because even price change, consumer continues to purchase and consume that commodity. Examples, Alcohol, Tobacco etc.

Level of own price of good




Higher own price of a good like car, gold etc have elastic demand because their demand is very sensitive to change in price and vice-versa.



Measurement of Price Elasticity by Total Expenditure Method


We measure elasticity of demand on basis of change in total expenditure in response to a change in price. This method was given by Professor Alfred Marshall.
Total expenditure  = Quantity demanded * Price
Following points should be noted to measure elasticity of demand by expenditure method.

                          
                              When Price Increases
1.       If expenditure remains same
Ed = 1
Unitary Elastic demand
2.      If Expenditure falls
Ed >1
More than unitary elastic
3.      If Expenditure increases
Ed<1
Less than unitary

                                When price falls
1.       If expenditure remains same
Ed = 1
Unitary Elastic demand
2.      If Expenditure falls
Ed <1
More than unitary elastic
3.      If Expenditure increases
Ed>1
Less than unitary
  




elasticity of demand by expenditure method

Never measure elasticity in absolute terms


Never measure elasticity of demand is terms of an absolute change in quantity in response to a given change in price of the commodity.
Now the question arises that what is absolute change in quantity. Let us understand with an example.




Never ,measure elasticity in absolute terms


Thus in the above figure one may conclude that Ed>1 because PP1 (Change in price) > MM1 (change in quantity) but this conclusion is wrong. You should measure elasticity in terms of percentage at point S.
Let us take an illustration.

Assumed values : Q =10, Q1=15,   Change in   Q = 5; P=5, P1= 40,    Change in P= -10

Ed =(-) change in Q * P/ change in P*Q
= (-) 5*50/-10*10
=  2.5

Hence Ed = 2.5 even when PP1 is greater than MM1

Flatter and Steeper Curve of Demand


Do you know that what is meant by flatter and steeper curve of demand in terms of elasticity?  It is very simple. Flatter curve is more elastic than steeper curve. Steeper curve is less elastic than flatter curve.  In other words, when a demand curve is flatter, change in quantity demand is greater than steeper curve.  You can understand well with help of following diagram:

Flatter curve is more elastic than steeper curve


In the above diagram:
  •   D1 and D2 are two demand curves starting from the point R
  •    D2 is flatter and D1 is steeper.
  • ·Now, when price reduces to OR1 from OR then quantity demand for D1   increases from zero to OM1 
  •    D2 curve shows rise in quantity demanded from zero to OM1
Hence OM1 is greater than OM. We can say that flatter curve is more elastic than steeper curve.


Cross Price Elasticity




The degree of change in demand of a commodity due to change in price of related goods is known as cross price elasticity.

Example :  If demand of tea changes by 2% due to change in price of its substitute good coffee by 1% then this type of measurement of elasticity is known as cross price elasticity of demand.

Ed       =          % change in quantity of good A/ % change in price of good B

Substitution Elasticity  
      
The substitution elasticity indicates that to what extent one commodity can be substituted for another without making any change in total satisfaction. It is the measure of ease or difficulty with which one commodity is substituted with other.

There are two situations:

*      Substitution elasticity may be infinite. It is happened when goods are perfect substitutes.

*     Substitution elasticity may be zero. It happens when goods are not perfect substitutes. There can be no substitution. Goods must be used in fixed quantity or proportion.
 
 





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