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

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1 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 variable X responds to a change in variable Y, variable X is said to be elastic. 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 The different kinds/ degree of Price Elasticity of demand The different types are:- 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 there is no change in demand inspite of substantial increase or decrease in price. ( 1 )

2 Price Qty dd Ed= Relatively Elastic Demand: When a percentage change in demand is much greater than percentage change in price. Ed > 1 Price Rs Qty dd (Kgs) 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) ( 2 )

3 5. 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 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 necessary.its demand is inelastic. ( 3 )

4 3) Proportion of Total expenditure spent: Products that consume a small portion of the consumer s income its demand is inelastic. 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 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. 7) Habits: Those goods which have become habitual necessities for the consumers, have low price elasticity. 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. Percentage method/proportionate method of elasticity of demand. The elasticity of demand is measured by dividing % change in quantity demanded of a product to the % change in price. Ed= Percentage change in quantity demanded. Percentage change in price. ( 4 )

5 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. iii. 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. 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. ( 5 )

6 This happens in case of inexpensive necessities 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 Ec= % Change in Price of Y 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. Expenditure method of calculating elasticity To identify elasticity by the expenditure method follow the following table The above table is refelected in the graph below: ( 6 )

7 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) 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 ( 7 )

8 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. INSTRUCTIONS TO STUDY THIS CHAPTER: Please read your book for detailed information of the above topics. The length of the answer depends on the marks in the question paper and may not only be substituted with what is mentioned in the notes. Examples can be used to elaborate your points for this chapter. ( 8 )

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