First Term Weekly Test ECONOMICS. ECONOMICS STD 10 (ICSE) Ch. 3. ELASTICITY OF DEMAND

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1 First Term Weekly Test ECONOMICS ECONOMICS STD 10 (ICSE) Ch. 3. ELASTICITY OF DEMAND 1. What is the meaning of Elasticity of Demand? Ans. The term elasticity indicates responsiveness of one variable to a change in another variable. For example, when variable X responds to a change in variable Y, variable X is said to be elastic. 2. Define Price Elasticity of demand. Ans. Price elasticity of demand measure the degree of responsiveness of demand for a commodity due to change in its price. Elasticity of demand is the ratio between percentage change in quantity demanded and percentage change in price. % Change in quantity demanded. Ed= % Change in Price Ed= ^ Q X P ^P Q Q= Original demand ^Q= Change in demand P= Original price ^P= Change in price 3. What are the different types/ kinds/ degree of Price Elasticity of demand? Ans. The different types are:- i. Perfectly Elastic demand : When no change or a very small change in price causes an infinite change in quantity demanded of a commodity. ( This type of situation is generally not found in real life) Ed= Price Qty. Rs. demanded ( 1 )

2 ii. Perfectly Inelastic demand: When there is no change in quantity demand in spite of substantial increase or decrease in price. (This type of situation is generally not found in real life) Ed= 0 Price Qty demanded Rs iii. Relatively Elastic Demand: When a percentage change in quantity demand is much greater than percentage change in price. Ed > 1 Generally seen in: Luxury goods When close substitutes available Expenditure on commodity is large Commodity has various uses Price Qty demanded Rs iv. Unit elastic demand. When percentage change in quantity demanded is equal to percentage change in price. The demand curve takes the shape of rectangular hyperbola. Ed=1. eg. If the price increase by 20%; demand decrease by 20% (Rectangular hyperbola is the curve under which all rectangles have equal area.it is a rare phenomenon) Price Rs Qty dd v. Relatively Inelastic demand: When percentage change in quantity demanded is lesser than percentage change in price. A substantial change in prices has little effect on quantity demanded. Generally seen when: Close substitute not available Expenditure on it is very small It is a necessary good When demand is urgent. ( 2 )

3 Ed<1 Price Rs Qty. dd Mention the factors affecting elasticity of demand. Factors Affecting the Price Elasticity of Demand 1. Nature of a commodity: If you regard a product as a necessity, then your demand for it will be inelastic: you re willing to pay any reasonable price, e.g. gasoline If you think it s a luxury, then your demand is very elastic and it may drop considerably due to an increase in price, e.g. IPL ticket, car. 2. Availability of substitutes: The more possible substitutes, the greater the elasticity. Example. Coke and Pepsi. If the price of coke goes up, people will be tempted to buy Pepsi. The demand of coke will therefore fall. In case of salt, it has no close substitute and is a necessity, its demand is inelastic. 3. Proportion of Total expenditure spent: Products that consume a small portion of the consumer s income has inelastic demand. Example, a consumer spends a very small proportion of income on purchase of match boxes. Therefore, even large change in its price will not induce him to change his level of demand. 4. Time period : Elasticity tends to be greater over the long run because consumers have more time to adjust their behavior and find a substitute for a commodity. On the other hand, in the Short- period because the consumer gets comparative less time to make adjustment, demand becomes relatively less elastic. 5. Number of uses: The greater the number of uses of a commodity, the higher is the price elasticity of demand. Example. Milk can be used to make cheese, butter, curd etc. If its price rises, it will be put to only important uses like serving the children or for the sick members in the family. Thus, its overall demand will fall to a large extent. 6. Possibility of postponement: If the demand for a particular commodity cannot be postponed its demand will be inelastic, Example medicines, food etc. Whereas, commodities like TV set etc. Its demand will fall to a large extent when price rises because it is not an urgent commodity 7. Habits: Those goods which have become habitual necessities for the consumers have low price elasticity. Even if the price rises, the consumer due to his addiction, will not be able to lower his demand. Example. Cigarettes, drugs etc. 8. Price-level: Highly priced goods have low price elasticity or inelastic demand. Example diamonds because the consumer does not react much to change in price Low priced goods have low price elasticity or inelastic demand. Example coarse cloths because the consumer does not react much to change in price Medium-class commodities are more elastic. Example, watches, Cycles etc. because the consumer reacts to change in price. 9. Joint demand They also affect the elasticity of demand. ( 3 )

4 Example. If the demand for pen is inelastic the demand for ink will also be inelastic. 9. Explain the percentage method/proportionate method of elasticity of demand. The elasticity of demand is measured by dividing percentage change in quantity demanded of a product to the percentage change in price. Ed= Percentage change in quantity demanded. Percentage change in price. % Change in quantity demanded. Ed= % Change in Price Ed= ^ Q X P ^P Q Q= Original demand ^Q= Change in demand P= Original price ^P= Change in price IMPORTANCE OF ELASTICITY OF DEMAND. 1. Importance to the producer. Every producer has to decide the price of his product. If the demand for his product is less elastic, he will fix up a higher price in order to earn more profit and if the demand for his product is elastic, he will fix up a lower price. 2. Importance to a finance Minister. The finance minister makes use of this concept while imposing taxes. He often imposes higher taxes on commodities which has less elastic demand and can easily raise revenue. On the other hand commodities with elastic demand may be taxed less. 3. Importance in Factor Pricing. The factor of production for which the demand is less elastic can obtain a higher price as compared to those having elastic demand. Eg., workers producing goods having inelastic demand can easily get their wages raised. 4. Importance in international trade. The concept of elasticity of demand helps in determining the terms of trade between two countries. Eg.,If Bangladesh knows India s demand for jute is inelastic, it can easily increase the price of jute. TYPES OF ELASTICITY OF DEMAND. 1. Price elasticity of demand. Price elasticity of demand is the degree of responsiveness of demand for a commodity due to change in its price. % Change in quantity demanded. Ed= % Change in Price 2. Income elasticity of demand. Income elasticity of demand is the degree of responsiveness of demand for a commodity due to change in income. ( 4 )

5 % Change in quantity demanded. Ei= % Change in Income. Ei=^Q Q ^Y Y Q= Original demand ^Q= Change in demand Y= Original income ^Y= Change in income Types of income elasticity of demand. i. Positive income elasticity of demand They are those goods, the demand for which increases with the increase in income of the consumer. This happens in case of normal goods. ii. Negative income elasticity of demand They are those goods, the demand for which falls as income of the consumer increases. This happens in case of inferior goods. iii. Zero income elasticity of demand When there is no change in demand in spite of substantial increase or decrease in income, the demand is called perfectly income Inelastic. Cross elasticity of demand. Cross elasticity of demand is the degree of responsiveness of demand for a commodity X due to change in price of Y. % Change in quantity demanded of X Ec= % Change in Price of Y Ec= ^Qx Qx ^Py Py Ex. When there is rise in price of tea demand for coffee will increase. Qx= Original demand for commodity x ^Qx= Change in demand for commodity x Py= Original price of commodity y ^Py= Change in price of commodity y Types of cross elasticity of demand. Positive cross elasticity of demand Cross elasticity of demand in case of substitute goods will be positive because a change in price of one commodity will change the demand for another commodity in the same direction Negative cross elasticity of demand Cross elasticity of demand in case of complementary goods will be negative because a change in price of one commodity will change the demand for another commodity in the opposite direction. ( 5 )

6 Ex. If price of petrol will go up demand for car will decrease. Zero cross elasticity of demand. Commodities which are not related to each other have zero cross elasticity of demand. Ex. any change in price of milk will not bring any change in the demand for cloth. LAW OF DEMAND Other things being equal, as the price of a good or service rises, its quantity demanded falls and vice versa. The law indicates the direction of change. ELASTICITY OF DEMAND Price elasticity of demand measures the degree of responsiveness Of demand for a commodity due to change in its price Elasticity of demand indicates the magnitude of change ABSOLUTE CHANGES RELATIVE CHANGES Absolute changes in price and quantity are Relative changes do not depend on units of measures in terms of the original units measurement. These changes are expressed in the same units. These are calculated as percentage changes in price and quantity. ( 6 )

STANDARD XII (ISC) ECONOMICS Chapter 4: Elasticity of Demand

STANDARD XII (ISC) ECONOMICS Chapter 4: Elasticity of Demand Meaning of Elasticity of Demand The term elasticity indicates responsiveness of one variable to a change in another variable. For example, when