ELASTICITY OF DEMAND

The law of demand explains that demand will change due to a change in price of the commodity. But it does not explain the rate at which demand

changes to a change in price. The concept of elasticity of demand measures the rate of change in demand.

The concept of elasticity of demand was introduced by alfred marshall. According to him the elasticity(or responsiveness) of demand in market is great or small according as the amount demanded increases much or little for a given fall in price, and diminishes much or little for given rise in price, and diminishes much or little for a given rice in price

The tool of elasticity of demand helps us in understanding demand relationship by providing us a quantitative value for the responsiveness of the quantity demanded to changes in the various factors in the demand function.

In general, demand elasticity is simply a measure of relative responsiveness of quantity demanded to changes in one of the specific, elasticity of demand (ed) is defined as the ratio of the percentage of change in quantity demanded to the percentage change in the demand determinant under consideration. That is

percentage change in quality demanded of good x ed = percentage change in determinant Z

where the parameter Z may be one of the following: 1 2 3 4 current price of the commodity(Px), current price of related good(Px), current income (Y), the expected price of the commodity (Epx), and

5 Advertisement expenditure (A), etc

TYPES OF ELASTICITY OF DEMAND

There are three types of elasticity of demand; 1 2 3 4 5 price elasticity of demand; Income elasticity of demand; cross elasticity of demand: Promotional elasticity of demand: Expectations elasticity of demand.

PRICE ELASTICITY OF DEMAND

the degree of responsiveness of quantity demanded to a change in price is called price elasticity of demand

The measure of relative responsiveness of quantity demanded to price along a give demand curve is known as price elasticity of demand. It can be represented mathematically as, price elasticity of demand(ep) proportionate change in quantity demanded of good X = proportionate change in price of good X

(Q2-Q1)/Q1 = (P2-P1)/P1

where Q1 and P1 are original quantity and price respectively, and Q2 and P2 are the new quantity and price respectively. The above equation can be rewritten as,

^Q/Q1 ^Q+^p ep = ^P/P1 =Q1 P1

^Q P1 ^Q P1 = Q1*^P = ^P*Q1

The elasticity of demand is linked to the law of demand, the coefficient of price elasticity of demand ep, will always have a negative sign-- negatively( or, downward) sloping demand curve. In order to avoid confusion in interpretation, only the absolute value of ep is taken, i.e., the sign ignored.

TYPES OF PRICE ELASTICITY OF DEMAND Important methods for calculation price elasticity of demand are 1 2 3 4 Percentage method Point method or slope method Total outlay method Arc method

1.PERCENTAGE METHOD In this case, elasticity of demand is measured as per cent(or proportionate) change in the quantity demanded divided by percent (or proportionate) change in price of the commodity. That is,

^QP Point ep= ^pQ

And ^Q (P1+P2) Arc ep = ^P*(Q1+Q2)

2.POINT METHOD We can calculate the price elasticity of demand at a point of the linear demand curve. The point elasticity concept is more precise than that of arc elasticity. If the two points, between which arc elasticity is measured are moved closer and closer together, arc elasticity becomes point elasticity as the distance between the two points approaches zero. The point elasticity of demand is defined as the proportionate change in quantity demanded resulting from a very small change in price of that commodity. It may be expressed as,

^Q P Point ep= - ^P *Q

Linear Demand Curve. If the demand curve is linear

Q= b0-b1p

dQ its slope = dp= -b1 Substituting this in the elasticity formula, we get

P ep= - b1.Q

3.OUTLAY METHOD

Another method of measuring elasticity of demand of a product at a particular level of price is through observing how the price change affects the total revenue of the form through influencing the quantity demanded of that commodity. The total revenue does not change when the elastisity of demand is unity. Quantity changes less than proportionately to rice change n case of inelastic demand bus more than proportionately in case of elastic demand.

4.ARC ELASTICITY Segment of a demand curve between two points is called an Arc.

Arc elasticity is a measure of average responsiveness to price change over a finite stretch on the demand curve. The percentage changes in quantity and price are different depending upon the price and quantity from which we start. The difference in the starting point leads us to different values of elasticity coefficient.

^Q

(P1+P2)

Arc ep=^P * (Q1+P2)

This expression of arc elasticity, however, shows that the arc elasticity between any two points of a demand curve is an approximation. If arc elasticity has to be meaningful, it must be computed between points on the demand curve that are close enough.

INCOME ELASTICITY OF DEMAND: income elasticity of demand for the commodity shows the extant to which a consumer's demand for the commodity changes as a result of a change in his income. Like price elasticity of demand, the income elasticity of demand may be defined as the ratio of percentage change in the quality demanded of a good, say X, to the percentage change in income of the consumer.

Percentage change in the quantity demanded of good X Ey= percentage change in income of the consumer ^qx ^Y

= qx / Y

TYPES OF INCOME ELASTICITY 1 2 3 4 5 High income elasticity Unitary income elasticity Low income elasticity Zero income elasticity Negative income elasticity

CROSS ELASTICITY OF DEMAND

In actual situations, commodities have definite groups of substitutes and complements. In the demand function it was mentioned that the demand for a commodity is nor only a function of its own price but also a function of the price of related goods. Hence, the concept of elasticity of

demand can also be applied in a situation where two commodities are related to each other. The elasticity in this case is called cross elasticity of demand. The concept of cross elasticity of demand is useful in handling inter-commodity demand relations. Cross elasticity of demand is defined as the ratio of the percentage change in demand for one good to the percentage change in the price of some other good. This change in the demand for one good due to a change in the price of some other good comes about because of the fact that the two goods may be either substitutes or complements to each other. Once we assume that two commodities X and Y are related, the expression of crosselasticity of demand would be,

^qx py exy= ^py* qx

TYPES OF DEMAND
1. Producers goods and consumers goods:
Producers goods are those which are used for the production of other goods-either consumer goods or producer goods themselves. Examples of such goods are machines, locomotives, ships etc. Consumers goods are those which are used for final consumption. Examples of customers goods can be readymade clothes, prepared food, residential houses etc.

2. Durable goods and perishable goods:

Consumers goods may be further sub-divided into durable and perishable goods. Perishable goods are those which cannot be consumed more than once; for e.g. bread, milk etc. These will meet only the current demand.

Durable goods are those which can be consumed more than once over a period of time, e.g. a car, a refrigerator, a readymade shirt and umbrella. The demand for durable goods is likely to be a derived demand.

3. Derived demand and Autonomous demand:

when a product is demanded consequent on the purchase, of a parent product, its demand is called derived demand. For e.g. the demand for cement is derived demand, being directly related to building activity. If the demand for a product is independent of demand for other goods, then it is called Autonomous demand. But this distinction is purely arbitrary and it is very difficult to find out which product is entirely independent of other products.

4. Industry demand and company demand:

The demand industry demand is used to denote the total demand for the products of a particular industry, e.g. the total demand for steel in the country. On the other hand, the term company demand denotes the demand for the products of a particular company, e.g. demand for steel produced by the Tata iron and steel company.

5. short-run demand and long-run demand:

Short run demand refers to demand with its immediate reaction to price changes, income fluctuation, etc., whereas long run demand is that which will ultimately exist as a result of the changes in pricing, promotion or product improvement, after enough time is allowed to let the market adjust to the new situation. For e.g. if electricity rates are reduced, in the short run, the existing users will make greater use of electric appliances. In the long run more and more people will be induced to use electric appliances.