# ECONOMICS CHAPTER 4: ELASTICITY OF DEMAND Class: XII (ISC) Meaning of Elasticity of Demand

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1 Meaning of Elasticity of Demand ECONOMICS CHAPTER 4: ELASTICITY OF DEMAND Class: XII (ISC) The term elasticity of demand indicates responsiveness of quantity demanded due to change in any of its determinants. This is a measure of how sensitive the quantity demanded is to the change in any of the factors affecting demand. There are three main types of elasticity of demand: I. Price elasticity of demand. II. Income elasticity of demand. III. Cross elasticity of demand. I. Price Elasticity of demand. Price elasticity of demand measure the degree of responsiveness of demand for a commodity due to change in its price Percentage Change in quantity demanded. Ed= Percentage Change in Price The different kinds/ degree of Price Elasticity of demand 1. Perfectly Elastic demand: When no change or a very small change in price causes an infinite change in quantity demanded of a commodity. Ed = Price Rs Qty demanded (Kgs) Perfectly Inelastic demand: When quantity demanded of a commodity does not respond to a change in its price then elasticity of demand is zero. Ed=0 ( 1 )

2 Price Qty dd Price Qty dd Rs (Kgs) Relatively elastic 3. Relatively Elastic Demand: When a percentage change in quantity demanded is much greater than percentage change in its price. Ed > 1 4. Unit elastic demand. When the extension or contraction in demand is proportional to price changes. The demand curve takes the shape of rectangular hyperbola. Ed = 1 Price Rs Qty dd (Kgs) Relatively Inelastic demand: When a substantial change in prices has little effect on extension or contraction in demand of the commodity. Ed < 1 Price Rs Qty dd (Kgs) 8 90 ( 2 )

3 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. A change in price of the neccesities may have a small impact on their quantity demanded 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 necessary. its demand is inelastic. 3) Proportion of Total expenditure spent: Products that consume a small portion of the consumer s income its demand is inelastic, because a change in its price does not make a much difference in the budget of the consumer 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. the other hand the demand for the products on which the consumer spends a large fraction of their income, a change in their price will have a considerable effect on the budget and therefore its demand will be elastic 4) Time period: Elasticity tends to be greater over the long run because consumers have more time to adjust their behavior and vice-versa. 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. 6) Possibility of postponement: If the demand for a particular commodity cannot be postponed its demand will be inelastic, Example medicines, food etc. and vice versa. ( 3 )

4 7) Habits: Those goods which have become habitual necessities for the consumers, have low price elasticity because they will continue to consume even at a higher prices. Example. Cigarettes, drugs etc 8) Price-level: Highly and low priced goods have low price elasticity or inelastic demand. Example diamonds and coarse cloths Medium-class commodities are more elastic. Example, watches. Cycles etc. METHODS TO CALCULATE PRICE ELASTICITY OF DEMAND There are three methods to calculate price elasticity of demand 1. Percentage method/proportionate method of Price elasticity of demand. The elasticity of demand is measured by dividing % change in quantity demanded of a product to the % change in its price. Ed= Percentage change in quantity demanded. Percentage change in its price. 2. Expenditure method of calculating elasticity a. Elastic When due to the fall in price, the quantity demanded of the good rises so much that, the total expenditure made on the goods increases, the price elasticity of demand will be greater than unity i.e elastic.(this is so because with a fall in price the total expenditure can increase only if the proportional increase in the quantity demanded is greater than the proportional change in price). b. Inelastic If as a result of fall in the price of the goods, the total expenditure decreases, the price elasticity of demand will be less than unity. This is because with the fall in price the total expenditure can decrease only if the proportional increase in the quantity demanded is less than the proportional fall in the price. c. Unitary elasticas a result of the change in price of the quantity demanded of a good the total expenditure remains the same, the elasticity of demand for goods will be equal to unity. (This is because total expenditure made on the goods can remain the same only if the proportional change in quantity demanded is equal to the proportional change in price). ( 4 )

5 To identify elasticity by the expenditure method follow the following table The above table is refelected in the graph below: 3.Geometric Method of calculating elasticity Geometric method was suggested by Prof. Marshall and is used to measure the elasticity at a point on the demand curve. When there are infinitely small changes in price and demand, then the Geometric Method is used. This method is also known as Graphic Method or Point Method or Arc Method. Elasticity of demand (Ed) is different at different points on the same straight line demand curve. In order to measure Ed at any particular point, lower portion of the curve from that point is divided by the upper portion of the curve from the same point. Elasticity of Demand (Ed) = Lower segment of demand curve (LS) Upper segment of demand curve (US) ( 5 )

6 Following the above formula we get the following different values at different points ondd To calculate elasticity of demand on a non-linear demand curve In order to measure elasticity in case of a non linear curve we draw a tangent at the given point R on the demand curve DD and then measure price elasticity by finding out the value of RT /RT. ( 6 )

7 TYPES OF ELASTICITY OF DEMAND. 1. Price elasticity of demand. Price elasticity of demand measure 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 measure the degree of responsiveness of demand for a commodity due to change in income. % Change in quantity demanded. Ey= % 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. For normal commodities we can classify elasticity into following:- Income elastic when the percentage change in quantity demanded is more than the percentage change in the income Income inelastic - when the percentage change in quantity demanded is less than the percentage change in the income Unitary income elastic - when the percentage change in quantity demanded is equal to the percentage change in the income 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. This happens in case of inexpensive necessities 3. Cross elasticity of demand. Cross elasticity of demand measure the degree of responsiveness of demand for a commodity X due to change in price of Y % Change in quantity demanded of X Exy= % Change in Price of Y ( 7 )

8 Types of cross elasticity of demand. i. 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. Ex. When there is rise in price of tea demand for coffee will increase. ii. 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. Ex. If price of petrol will go up demand for car will decrease. iii. Zero cross elasticity of demand. Commodities which are not related to each other other have zero cross elasticity of demand. Ex. any change in price of milk will not bring any change in the demand for cloth ( 8 )

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