Demand and Supply

The Concept of Demand, Supply & Elasticity
Subject: Economics
Lesson: The Concept of Demand, Supply & Elasticity
Author: Nalini Panda, Associate Professor
Department/ College: Indraprastha College for Women, University of
Delhi
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Institute of Lifelong Learning,University of Delhi
Table of Contents
 Introduction
o 1.1 demand and Supply
o 1.1.Supply
o 1.1.3 Equilibrium
o 1.2.1 Elasticity of Demand
o Summary
o Exercise
o Glossary
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1.1 demand and Supply

One of the main tasks of economic theory is to explain why goods have prices and why
some goods are expensive and others cheap. The answer is that they have prices
because, on the one hand, they are useful and, on the other hand, they are scarce in
relation to their various alternative uses. For example, people will have no use for
woolen clothing in a place where temperature is always above 30°C and hence woolens
will never command a price in that locality. In addition to being useful, goods must be
scarce in relation to the uses to which people want to put them, if they are to be priced.
For instance, while air is clearly useful to every human being, it does not command a
price because it is freely available in unlimited amounts. Goods like air, which are useful
but not scarce, are known as ‘free’ goods and do not bear a price. By contrast, economic
goods are scarce and do bear a price. It is only because economic goods are useful that
they are demanded by buyers, and only because they are scarce that sellers cannot
supply them in unlimited quantities. Thus price of any economic good or service is
determined by the interaction of demand and supply. It is now necessary to see more
precisely what demand and supply are.
1.1.1 Demand
1.1.1 (a) An Individual’s Demand for a Product

The demand for a good by an individual consumer (or household) means this individual’s
desire for the good backed by a capacity to pay.
Source: www.drawingcoach.com, www.photos.merinews.com
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The quantity of a good an individual is willing to buy over a specific time period is a
function of the price of the good, the individual’s money income,and the prices of other
goods. In simple mathematical language it can be expressed as:
Qdx = f (Px, I, Po) (1.1)
where Qdx = the quantity of good X demanded by the individual, over the specific time
period,
f = a function of, or depends on, P x = the price of good X,

I = the money income of individual, Po = the prices of other goods.
In any particular situation if we keep factors other than own price as constant, we can
derive the individual’s demand function for the good as
follows :
(1.2)
where, the ‘bar’ on top of Iand Po means that they are kept constant. Equation (1.2) can
also be written as
Qdx = f (Px) cet. par. (1.3)
where, cet. par. = ‘ceteris paribus’ means everything else held constant.
Eqn(1.3) implies that the quantity of good X demanded by an individual over a speific
time period is a function of the price of that good, while holding constat everything else
that affects the individual’s demand for the good.
Eqn(1.3) is a ‘general’ functional relationship between quantity demanded of the good X

at various alternative prices of X, ceteris paribus. We can also take a ‘specific’ demand
function. For example,
Qdx = 32 – 4Px cet. par. is a specific functional relationship indicating precisely how Qdx
depends on Px. That is, by substituting various prices of good X into this specific demand
function, we get the particular quantity of good X demanded by the individual per unit of
time at these various prices. Thus, we get the individual’s demand schedule.
In general, the individual’s demand schedule for a good is a table giving us the quantity
demanded of the good at various alternative prices of the good, keeping constant the
prices of other goods and money income and tastes of the consumer. The graphic
representation of the individual’s demand schedule gives us that person’s demand curve.
In the previous example where the demand function for an individual for good X is given
as Qdx = 32 – 4Px, if we substitute various prices of X into the demand function we will
get the individual’s demand schedule as given in Table 1.1.
Table 1.1
Px (in Rs.) 8 7 6 5 4 3 2 1 0
Qdx 0 4 8 12 16 20 24 28 32
Plotting each pair of values as a point on a graph and joining the resulting points, we get
the individual’s demand curve for good X. In Fig. 1.1 it is shown as dx
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Figure 1.1: Linear Demand Curve
The individual buys the good X only when price falls below Rs. 8. At a price of Rs. 7 she
buys 4 units of X. As the price falls further, she purchases more of X because they are
becoming less expensive. At a price of Re1, she buys 28 units. However, even at a price
of Rs.0 she would not take more than 32 units because additional units of X may result
in a storage and disposal problem for the consumer. This is called the ‘saturation point’
for the individual. So the maximum quantity that the individual will ever demand of good
X per time period is 32 units.
In drawing the demand curve dx in fig. 1.1.1, we assume complete divisibility, so that
price and quantity demanded can both change by infinitely small steps. This enables us
to draw a demand curve by joining the points A, B, C, D... I by a continuous, smooth
line. Another point to be noted about the construction of the demand curve is that the
independent variable, price, is measured on the vertical axis, and the dependent
variable, quantity, on the horizontal axis which contradicts the mathematical principle of
drawing a curve. But this is a convention which economists follow so that they can draw
the demand curve of the consumers and the cost curves of the firms on the same set of
axes. The demand curve drawn this way is also called the inverse demand curve.
In the given example,the demand curve for the good X is a straight line and is of the
form of
Qdx = a – b Px, (1.4)
Where ‘a’ (32) is the quantity intercept and ‘–b′ (–4) is the slope, i.e.,
When we plot the demand curve, we actually plot the inverse demand curve which is
given as:
Px = α – β Qdx, (1.5)
Where is the price intercept and is the slope of the inverse demand curve
and equals
In our example, α = (32/4) = 8, is the price intercept, and –β = -(1/4), is the slope of
the inverse demand curve.
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Though in the previous example the demand curve derived is linear, it is not always so.
Suppose Table 1.2 gives us the demand schedule for good Y for an individual.
Table 1.1.2
Py(in 90 80 70 60 50 40 30 20 10 0
Rs.)
Qdy 0 1 2 3 5 8 12 16 20 30
The demand curve that will be derived will be non-linear as shown

in fig. 1.2.
Figure 1.2: Non Linear Demand Curve
Value Addition: Know more about non-linear demand functions
A non-linear demand function may take the following form.
Qdx = a(1/Pxb), (i)
Where, a and b are positive constants.

The slope of the demand curve can be derived by taking the first derivative of the
demand function.
(dQdx/dPx) = -a.b(1/Pxb+1 ). (ii)
It is clear from the previous equation that the slope of the demand curve is negative and
it varies with the price. Hence, the demand curve that will be derived from equation-(i)
is a downward sloping, non-linear curve.
Let us suppose that a=100 and b=1. Then, the specific demand function will be,
Qdx = 100/Px (iii)

The demand schedule that can be derived from (iii) is given as follows:
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Px (in Rs.) 0 1 2 4 5
Qdx (in units) ∞ 100 50 25 20
The demand curve derived will be non-linear. In fact, it will be a rectangular hyperbola,
i.e., it will be asymptotic to both the axes and the areas of the rectangles formed under
the curve will be equal to each other.
In the given figure, dx is a demand curve which is a rectangular hyperbola. Area of the
rectangle OP1AQ1=area of OP2BQ2=area of OP3CQ3=area of OP4DQ4=100.
The individual’s demand curve for a good represents a maximum boundary of the
individual’s intentions. For the various alternative prices of a good, the demand curve
shows the maximum quantity of the good the individual intends to purchase per unit of
time. For various alternative quantities of a good, the demand curve shows the
maximum prices the individual is willing to pay. For example, in fig.1.2 point E on the
demand curve indicates two things. First, if the price is given as Rs.50, the individual will
buy maximum 5 units of good Y Second, the maximum price that the individual will be
willing to pay to buy 5 units of Y is Rs.50.
1.1.1 (b) Movements Along vs. Shifts in Demand
When there is a change in the price of one good, other things remaining constant, the
quantity demanded of that good changes and the consumer moves along the same
demand curve. The movement along the same demand curve for a good is known as the
change in the quantity demanded the good which occurs due to a change in the own
price, ceteris paribus.
For example, in Table 1.2, when price of Y falls from say Rs.50 to Rs.40, the quantity
demanded of Y rises or expands from 5 units to 8 units and the consumer moves from
point E to point F on the same demand curve ‘dy’.
However, when any of the ‘ceteris paribus’ conditions changes holding own price of the
good constant, the entire demand curve ‘shifts’ either to the right or to the left. A
rightward shift is called an increase in demand (rather than an increase in the quantity
demanded), and this shows that at any given price of the good, the consumer buys more
of the good. Similarly, with a leftward shift the consumer buys less of the good at any
given price. This is known as a decrease in demand.
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Reinforce your learning
Increase in Demand
Case Studie
Reducing the Quantity of Tobacco Demanded
The Government in an effort to control the spread of Oral Cancer is contemplating two
policy options to bring about reduction in tobacco (Gutka) consumption. One option is to
tax the tobacco manufacturers thereby increasing the price and thus reducing/
contracting the demand for tobacco. Alternatively the Government can make use of
public service announcements, health warnings on tobacco products, restrictions on
advertisements of tobacco products etc. These measures would shift the demand curve
of tobacco products to the left implying a decrease in the demand for tobacco products.
Shifts in the demand curve occur due to changes in income of the consumer or in the
prices of other goods or in the tastes of the consumer. When consumer’s money income
increase, while everything else remains constant, the consumer’s demand for a good
usually increases so that the consumer demands more of the good at the same price of
the good. These goods are referred to as normal goods. For example, with an increase in
the consumer’s income, the consumer’s demand for ‘mango’ may increase even though
price of ‘mango’ has not changed. This will lead to a rightward shift of the consumer’s
demand curve for mango. Similarly, a decrease in income will lead to a leftward shift of
the consumer’s demand curve.
Sometimes, with a rise in individual’s income the demand for certain goods may fall.
These goods are known as inferior goods. For example, with a rise in income consumer
may demand less of potatoes and switch over to better quality vegetables or fruits.
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The individual’s demand curve for a good shifts when prices of other goods in the
economy changes, own price of the good remaining constant. Change in the prices of
other goods will affect the demand for the good in question significantly when these
other goods are either close substitutes or complements of the given good.
A close substitute is a good that performs essentially the same function as the original,
so that a small increase in the price of the substitute will induce the consumer to buy
more of the original good even though it’s price has not changed. Thus, the demand
curve for the original good will shift to right. For example, let us suppose that for a
consumer ‘Tropicana’ fruit juice is a close substitute of ‘Real’ fruit juice. If price of ‘Real’
increases from Rs.70 to Rs.75, then, the demand of ‘Tropicana’ will increase from 2 litres
to 3 litres a month even though its price has remained unchanged at Rs.65 per litre.
A complement is a good that is used in conjunction with the particular good in question.
For example, pizzas and coke are complements of each other. When price of pizza rises,
price of coke remaining the same, the demand for pizzas as well as coke will fall and the
demand curve for coke will shift to left.
Figure 1.3: Shift In Demand Curve
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In fig. 1.4, d1 represents the demand curve for coke when price of one pizza was
Rs.100. At that time the consumer was consuming 5 bottles of coke at a price of
Rs.10/bottle. When price of pizza rises to Rs.150/unit, the demand curve for coke shifts
leftward to the position d2 and at the same price of coke (which is Rs.10/bottle), the
consumer reduces the demand to 3 bottles. This happens, because with an increased
price of pizza, consumption of both pizza as well as coke, falls. The opposite will happen
if price of pizza falls.
Figure 1.4: Shift In Demand Curve
1.1.1 (c) Substitutability and Narrowness of Definition
When a consumer buys a number of goods, it is possible for her to substitute other
goods for a particular good if its price rises. But the ability to substitute away from a
good increases with the narrowness of its definition. That is, the more narrowly a good is
defined; more substitutes are available for it, where as, the more broadly a good is
defined, less will be availability of its substitutes.
For example, food is a broader category than fruits and fruit is a broader category than
mango. As other goods in the individual’s consumption basket are very poor substitutes
of food, so with a rise in the price of food, the consumer will find it difficult to substitute
it with anything else. Whereas, if the good in question is fruit, then meat , milk,
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vegetables etc. are substitutes for fruits. So a rise in the price of fruits may induce the
consumer to substitute fruits by meat or milk or vegetables. Mango is even more
narrowly defined than fruits. Because other fruits like orange, banana and apple are
more close substitutes of mango than is milk for fruits, so with a rise in the price of
mango, the consumer immediately will switch over to other fruits.
1.1.1 (d) The Market Demand for a Product
The market demand for a good gives the alternative quantities of the good demanded
per time period, at various alternative prices, by all the individuals in the market. The
market demand for a good, therefore, depends on all the factors that determine the
individual’s demand and also on the number of buyer of the good in the market.
In particular, if there are 100 identical buyers in the market for good X, having the same
demand function Qdx = 32 – 4 Px, the market demand function will be simply given by
100 Qdx, i.e.,
QDx = 100 Qdx = 3200 – 400 Px, (1.6) where QDx is the market demand function. The
market demand schedule can be derived by substituting various prices of X into this
demand function. Market demand curve will be a graphical presentation of the market
demand schedule. Table 1.3 gives us the market demand schedule and fig. 1.5 gives the
market demand curve.
Table 1.3
Px (in Rs.) 8 7 6 5 4 3 2 1 0
QDx 0 400 800 1,200 1,600 2,000 2,400 2,800 3,200
Plotting each pair of values as a point on a graph and joining the resulting points, we get
the market demand curve. In fig. 1.5 Dx gives us the market demand curve for good X.
Figure 1.5: Market Demand Curve
In practice, individuals have different preferences and so they have different demand
functions for the same good X. In this case of people having different demand curves for
the same good, we can derive the market demand curve by horizontally adding up the
individual demand curves.
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For example, suppose there are just two individual buyers in the market for good Y
whose individual demand schedules are given as follows in Table 1.4
Table 1.4
Price Qd1y Qd2y
90 0 1
80 1 2
70 2 5
60 3 8
50 5 12
40 8 15
30 12 17
20 16 20
10 20 25
0 30 35
In fig. 1.6 we draw the individual demand curves d1y & d2y and their horizontal
summation give us the market demand curve Dy. At each price the quantities demanded
by both the buyers are summed up to give the market demand curve.
Figure 1.6: Derivation Of Markrt Demand Curve
When price is Rs.100 there is no demand for y by both the individuals. At Rs. 90,
individual 2 demands 1 unit of y but individual 1 still has zero demand,, thus the market
demand is 1 unit. At Rs.80, individual 1 demands 1 unit & 2 demands 2 units, so market
demand is 3 units. At Rs.40, 1’s demand is 8 units, 2’s demand is 15 units and so
market demand is 23 units and so on. In fig. 1.6, the market demand curve merges with
individual 2’s demand curve till point A2 and then to derive the market demand we
horizontally add up the points on the individual demand curves. For example, to derive
point B on the market demand curve we add up P8B1 and P8B2. So P8B = P8B1 + P8B2 so
that B2B is equal P8B1. Similarly, P4F = P4F1 + P4F2, such that F2F = P4F1 and so on.
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Solved Problem
Question:
Suppose that a good is demanded by just two consumers A and B. Their demand curves
are
qa = 80-8P
qb = 40-10P
i) Derive the individual demand schedules.
ii) Plot the individual demand curves and the market demand curve on the same set of
axes.
Solution:
i) Individual Demand Schedule for A
Price (in Rs.) 0 1 2 3 4 5 6 7 8 9 10

Quantity (in units) 80 72 64 56 48 40 32 24 16 8 0
Individual Demand Schedule for B
Price (in Rs.) 0 1 2 3 4

Quantity (in units) 40 30 20 10 0
(ii)
Plotting the individual demand schedule of A and B we get the demand curves dada’ and
dbdb’ respectively. The market demand curve, daCD, is a horizontal summation of the
two individual demand curves. Its price-intercept is at Rs.10 because if the price is Rs.10
or more there is no demand by both the consumers of the good and hence, the market
demand is zero. From the demand schedule of B it is clear that for any price greater than
or equal to Rs.4, B’s demand for the good is zero. Thus the market demand curve will
merge with A’s demand curve between the price Rs.10 and Rs.4. For any price below
Rs.4 we can obtain the market demand by adding the demand by A and B both. For
example, at price Rs. 2, A’s demand is 64 units and B’s demand is 20 units and the
market demand is 64+20=84 units. In the given figure Pea+Peb=PE. At zero price the
market demand is maximum 120 units.
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1.1.Supply
1.1.2 (a) An Individual Firm’s Supply Curve
Supply curves describe the seller’s desire to make the good available. The quantity of a
good that an individual firm is willing to supply over a specific time period is a function of
the price of the good and the cost of production. In order to derive the firm’s supply
curve of a good, we just vary the price of the good, factors influencing the cost of
production being held constant. The factors which influence cost of production are (i) the
prices of the factors of production which have helped in the production of the good, (ii)
technology and (iii) for agricultural goods, climate and weather conditions. A single firm’s
supply curve of a good shows the alternative quantities of the good that the firm is
willing to supply over a specific period of time at various alternative prices for the good,
while keeping the above constant.
In simple mathematical language this functional relationship can be expressed as follows

:
(1.7)
or, Qsx = g (Px) cet. par. (1.7´)
Where Qsx = the quantity supplied of good X by the single producer, over the specific
time period,
g = a function of,
Tech = technology,
Pi = the price of inputs,
Fn = features of nature such as climate and weather conditions.
The bar on top of the last three factors indicate that they are kept constant.
Equation (1.7) or (1.7´) is a general functional relationship. In order to derive a single
firm’s supply schedule and supply curve, we must get that firm’s specific supply function.
For example, let a single firm’s supply function for good X be
Qsx = –50 + 25 P x.
If we substitute various prices of X into the above supply function we will get the
individual supply schedule as given in Table 1.5.
Table 1.5 Individual Supply Schedule
Px (inRs.) 10 9 8 7 6 5 4 3 2
Qdy 200 175 150 125 100 75 50 25 0
Px (inRs.) 10 9 8 7 6 5 4 3 2
Qdy 200 175 150 125 100 75 50 25 0
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Plotting each pair of values as a point on a graph and joining the

resulting points, we get the individual firm’s supply curve.
The supply schedule and the supply curve show that the producer will supply the good
only if the price is higher than Rs.2. If the price is Rs.2 or less the price is so low that it
does not even cover the cost of production so that the firm does not intend to produce
and sell the good.
In the above example the supply curve is an upward-sloping straight line. An upward
sloping supply curve implies that the higher is the price of the good, the more willing the
producer will be to supply the good. A producer’s positively sloped supply curve for a
good represents in one sense a maximum and in another sense a minimum boundary of
the producer’s intentions. At any given price, it would indicate the maximum quantity of
a good that the producer is willing to supply. To put it in a different way, if a given
quantity of a good is to be supplied, the supply curve would indicate the minimum price
at which the producer would be willing to supply that quantity. For example, let us take
the point D on the supply curve sx in fig. 1.7. That point indicates that if the price is
Rs.7, then the producer will be willing to supply a maximum of 125 units of the good. It
also indicates that if the producer has to supply 125 units of the good, then Rs.7 is the
minimum price at which he would supply that quantity.
Even though the supply curve is usually positively sloped, it could also have a zero,
infinite, or a negative slope, and no generalisation is possible. Also when the supply
curve is positively sloped it can be linear, as in the given example, or non-linear.
1.1.2 (b) Movements along, versus, Shifts in the Supply Curve

One should distinguish between movements along a supply curve and shifts of the
supply curve. When price of the good in question changes, certeris paribus, the producer
moves along the same supply curve.
When factors other than own price of the good, affecting the supply of the good change,
the entire supply curve shifts. This is referred to as a change or shift in supply as
distinguished from a change in the quantity supplied.
For example, if there is an improvement in technology, so that the cost of producing

every unit of the good falls, the supply curve shifts downward. This downward shift is
referred to as an increase in supply. It means that at the same price for the good, the
firm offers more of it for sale per time period. The same thing happens when there is a
decrease in the prices of the inputs.
Fig. 1.8 is an extension of fig.1.7. Given the supply curve sx when price rises from Rs.4
to Rs.7, the producer moves along the same supply curve sx from C to D and quantity
supplied increases from 50 to 125 units. When due to decrease in the cost of production
supply curve shifts from sx to s’x, the producer shifts from point C on sx to C’ on s’x and
increases the supply of the good from 50 to 80 units even at the same price of Rs.4.
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Figure 1.8:Shift In Supply Curve
1.1.2 (c) The Market Supply of a Product
The market or aggregate supply of a good gives the alternative amounts of the good
supplied per time period at various alternative prices by all the producers of this good in
the market. In addition to all the factors that influence individual producer’s supply, the
market supply depends also on the number of producers of the good in the market.
If all the producers face identical cost conditions such that they have the same supply
functions then the market supply function can be derived simply by multiplying the
individual supply function by the number of producers in the market. In the previous
example, if there are 100 identical producers in the market having the supply function
Qsx = –50 + 25 Px, then the market supply function will be given by
QSx = 100 × Qsx = –5,000 + 2,500 Px
The market supply schedule will be given by Table 1.6.
Table 1.6 Market Supply Schedule

Px (in Rs.) 10 9 8 7 6 5 4 3 2
Qdy 2,000 17,500 15,000 12,500 10,000 7,500 5,000 2,500 0
The market supply curve is simply a graphical presentation of the market supply
schedule which can be drawn very much in the same way as fig. 1.7, only the scale on
the horizontal axis will have to change.
When individual producers face different cost conditions they will face different supply
functions and supply curves. In this case the market supply curve will be given by the
horizontal summation of the individual supply curves of all the firms in the market.
Let Table 1.7 give the supply schedules of the three producers of good X in the market.
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Table 1.7
Px Quantity supplied
(in Rs.) (per time period)
Firm 1 Firm 2 Firm 3
5 15 25 30
4 12 20 25
3 5 15 18
2 0 10 12
1 0 0 5
0 0 0 0
The individual supply curves of the three firms are drawn on the same set of axes in fig.
1.9 as sx1, sx2 and sx3. The market supply curve is given by Sx (OEDCBASx) which is a
horizontal summation of sx1, sx2 & sx3. Various points on the market supply curve are
obtained by adding up the quantities supplied by the individual producers at different
price levels. For example, at price Rs.5 (or P 5) the quantity supplied by firm 1 is P5A1
(15), by firm 2, P5A2 (25) and by firm 3 it is P5A3 (30). So the total quantity supplied in
the market at P5 price is P5A1 + P5A2 + P5A3 = P5A (70 units). The market supply curve
merges with Firm 3’s supply curve till price rises from Re.0 to Re1 and after that it
becomes a horizontal sum of s1x, s2x & s3x.
Figure 1.9:Derivation Of The Market Supply Curve
1.1.3 Equilibrium
Equilibrium is said to exist when opposing forces are in balance. In the market for a
particular good, demand and supply are like two opposing forces. The market is in
equilibrium at the price where the amount that is demanded equals the amount supplied.
This price is called the equilibrium price and the quantity demanded and supplied at this
price the equilibrium quantity. Market equilibium is shown graphically in Fig.1.10.
In fig.1.10 Dx is the market demand curve and Sx the market supply curve. They
intersect at point E. Only at price OP*, the quantity demanded is equal to the quantity
supplied which is equal to OQ*. At any price higher than OP* supply exceeds demand
and any price below OP*, demand exceeds supply and they are not in balance. So the
equilibrium price is OP* and the equilibrium quantity OQ*.
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Figure 1.10: Equilibrium
1.2.1 Elasticity of Demand

We know that the demand for a good is a function of its own price, prices of other goods,
and income of the consumer. The elasticity of demand is defined as the degree of
responsiveness of the quantity demanded of a good with respect to a change in the
variable on which the demand for the good depends. Accordingly we have own price
elasticity of demand; cross price elasticity of demand and income elasticity of demand
for a good.
1.2.1 (a) Own Price Elasticity of Demand
I. Definition and Measurement
Own Price elasticity of demand or,simply, the price elasticity of demand refers to the
relative responsiveness in the quantity demanded of a good with respect to a change in
its own pirce. The coefficient of price elasticity of demand is given by the percentage
(proportionate) change in the quantity demanded of a good divided by the percentage
(proportionate) change in its own price.
If a given percentage change in the price of a good results in a greater percentage

change in quantity demanded, then the coefficient of elasticity will be greater than one
and the demand is said to be relatively elastic. On the other hand, if a given percentage
change in the price of a good results in a smaller percentage change in quantity
demanded then the elasticity will be less than one and the demand is said to be
relatively inelastic. When a given percentage change in the price of a good results in an
equal percentage change in the quantity demanded, then elasticity is equal to one and
the demand is said to be unitary elastic. When a given percentage change in the price
results in no change in quantity demanded then the elasticity will be equal to zero and
the demand is said to be perfectly inelastic. When a slight change in price results in an
infinite change in the quantity demanded the elasticity of demand will be equal to infinity
and the demand is said to be perfectly elastic.
Since price and quantity demanded are inversely related, the coefficient of price
elasticity of demand is a negative number. In order to avoid dealing with negative
values, a minus sign is often introduced into the formula for the coefficient of price
elasticity. Thus, the formula for own price elasticity of demand for good X is given by the
following:
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where the numerator gives the proportionate change in the quantity demanded of X and
the denominator gives the proportionate change in the price of X.
Equation (1.8)
can also be
written as
For infinitesimally small change in quantity and price the formula for price elasticity will
be
where is
the inverse of the slope of the demand curve at a point where price is Px and quantity
demanded of the good is Qx. Equation (1.10) can, therefore, be written as :
and it gives us the formula to measure elasticity

at a point on the demand curve.
To measure elasticity between two points on the demand curve we may use the formula
given by equation (1.9). But while applying this formula to measure elasticity between
two points on a demand curve we would get different results depending on whether we
move from higher price to the lower price or from the lower price to the higher one. For
example, suppose we want to measure elasticity between points D & F on the market
demand curve Dx given in fig.1.5 which is reproduced in fig. 1.11. If we let the price fall
from Rs.5 to Rs3 and move from D to F on the demand curve Dx, then elasticity will be
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Whereas, if we let the price rise from Rs.3 to Rs.5 and move from point F to point D on
the same demand curve Dx, then elasticity will be
Thus, though we are measuring elasticity between the same pair of points on a demand
curve we are getting different results depending on whether we are moving from a
higher to a lower point or from a lower to higher point. This problem arises because the
elasticity of demand tends to vary from one point to another on the demand curve, and
for a large change in price and quantity we need an average value over the entire range.
Thus, when we deal with large changes in price and quantity, we should use the
following Arc Elasticity formula.
where P1 and P2 are the prices between which we want to find out the elasticity.
Following this formula, the elasticity between the points D and F on the demand curve
Dx in fig.1.11 will be
II. Graphical Presentation of Elasticity
Graphically the price elasticity at a point on a linear demand curve is shown by the ratio
of the segments of the line to the right and to the left of the particular point. It can also
be described as the ratio of the lower segment to upper segment. Let us look at the
linear demand curve given in fig.1.11.
Figure 1.11: Demand Curve
20
Elasticity of demand at point E on the demand curve AJ will be given by . It can be

proved as follows.
Elasticity of demand at point E is given by
Triangles AKE and ELJ are similar triangles and therefore, sides are proportionate.
It is clear from the figure that E is the mid point of the demand curve AJ. Therefore, EJ =
EA and hence
To measure elasticity at a point on a non-linear demand curve we draw a tangent to the

demand curve at that point so that it intersects the two axes. Then elasticity at that
point is given by the ratio of the segments of the tangent to the right and to the left of
the particular point.
In fig.1.12 the elasticity of the non-linear demand curve Dx at point E is given by

where AJ is a tangent drawn to the demand curve Dx at point E.
21
Figure 1.12: Non Linear Demand Curve
Elasticity at point E on the demand curve Dx is given by which is

equal to one
Arc elasticity between two points on the demand curve is equivalent to finding elasticity
at the midway between the two points. In fig.1.11, where the demand curve is a straight
line, the point midway between D and F is the point E which corresponds to the price
4 and quantity 1600 units. So arc elasticity between the two

points D and F is equal to elasticity at point E on the demand curve. In both the cases
elasticity is equal to one. Both arc elasticity and point elasticity give us the same result
here because the demand curve is a straight line.
In fig. 1.12, where the demand curve Dx is non-linear the point midway between D and
F is the point E′ which lies on the straight line joining the two points. So the arc elasticity
between the two points D and F on the non-linear demand curve Dx, is given by the
elasticity at point E′ which does not lie on the demand curve. In fig.1.12, the elasticity
corresponding to the price is given by the elasticity at point E on the demand
curve and it is given by The arc elasticity between

the two points, D and F, is given by elasticity at point E´, and it is given by
Now as DF is parllel to AJ, so the slope of the demand curve Dx

(which is equal to slope of AJ) is equal to the slope of DF. But OL′ > OL. Therefore, it is
clear that elasticity at point E´ is not equal to the elasticity at point E. Therefore, when
the demand curve is curvi-linear, the arc elasticity gives only an estimate of point
elasticity and the estimate improves as the arc becomes smaller and approaches a point
in the limit. In the fig.1.12, as points D and F on the demand curve Dx move closer to
each other, E´ approaches E, and therefore, the coefficient of elasticity at point E´ will
tend to be equal to elasticity at point E. The same thing will happen if the curvature of
the demand curve over the arc DF becomes less. Therefore, arc elasticity will give a
22
better estimate of point elasticity of demand on a curvi-linear demand curve as the

length of the arc becomes smaller and the curvature of the demand curve over the arc
becomes less.
Historical And Intellectual Context
History
Source: http://en.wikipedia.org/wiki/Price_elasticity_of_demand
Together with the concept of an economic "elasticity" coefficient, Alfred Marshall is

credited with defining PED ("elasticity of demand") in his book Principles of Economics,
published in 1890. He described it thus: "And we may say generally:— the elasticity (or
responsiveness) of demand in a 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 a given rise in price". He reasons this since "the only universal law as to a person's
desire for a commodity is that it diminishes... but this diminution may be slow or rapid.
If it is slow... a small fall in price will cause a comparatively large increase in his
purchases. But if it is rapid, a small fall in price will cause only a very small increase in
his purchases. In the former case... the elasticity of his wants, we may say, is great. In
the latter case... the elasticity of his demand is small." Mathematically, the Marshallian
PED was based on a point-price definition, using differential calculus to calculate
elasticities.
The illustration that accompanied Marshall's original definition of PED, the ratio of PT to
Pt
Example : Given the market demand function QDx = 3200 – 400 Px,
(i) Derive the market demand schedule.
(ii) Find elasticity when price falls from Rs.5 to Rs.4.
(iii) Find elasticity at Px = Rs.3.
Ans. (i) Market Demand Schedule
Px (in Rs.) 8 7 6 5 4 3 2 1 0
Qx (in Kgs) 0 400 800 1,200 1,600 2,000 2,400 2,800 3,200
(ii) Since the price has fallen by Re1, it is a finite change and so we use the concept of
Arc elasticity
23
(iii) Here we have to find elasticity at a point on the demand curve. So we use the point
method.
III. Elasticity of demand and slope of the demand curve

We know that elasticity at a point on the demand curve is given by
So the slope of the curve is only one of the factors that determine elasticity. The second
factor is the position of the point indicated by (P/Q), at which elasticity is evaluated.
Using this concept we can derive some important results on elasticity of demand.
(i) First, the elasticity of a down-ward-sloping straight-line demand curve varies from
infinity at the price axis to zero at the quantity axis. A straight line has a constant slope,
so its reciprocal is also constant at every point on the demand curve. So the value of
elasticity at any point will now depend on the ratio P/Q. At the price axis, Q = 0, and P/Q
is equal to infinity. Thus elasticity approaches infinity as quantity approaches zero.
In fig.1.13, the elasticity is equal to infinity at point D on the demand curve DE. As we
move down the line DE, price decreases and quantity increases steadily; thus P/Q is
falling steadily so that elasticity is also falling. At the quantity axis, that is, at point E on
the demand curve, price is zero, so the ratio P/Q equals zero and hence elasticity is
equal to zero.
This result can be interpreted in another way by using the definition of elasticity.
Elasticity refers to percentage change. Starting from point D on the demand curve, a
smallest reduction in price will increase the quantity demanded from zero to some
positive amount. Because the previously demanded quantity was zero, the increase is
infinite in percentage term. So elasticity at point D is equal to infintiy. At point E, any
increase in price from zero to a positive number is an infinite percentage increase
because the price was previously zero. Therefore elasticity at point E is equal to zero. By
using the geometrical formula for point elasticity, we can derive that elasticity at the
mid-point B on the demand curve DE, will be equal to = 1; at point A, it is equal to
>1 and at point C, it is equal to <1
24
An Example
Let us take the same demand function given in the previous example:
QDx = 3200-400Px.
Differentiating with respect to Px, we get, (dQDx/dPx) = -400.
By definition, ηxx = -(dQDx/dPx)*(Px/QDx).
At the price intercept of the demand curve, Px=8 and QDx=0, and ηxx = -(-400)*(8/0) =
∞.
At Px=6 and QDx=800, ηxx = 400*(6/800) = 3>1.
At Px=4, QDx=1600 and ηxx = 400*(4/1600) = 1. It can be observed that it is the mid
point of the given straight line demand curve.
At Px=2, QDx=2400 and ηxx = 400*(2/2400)= 1/3<1.
At the horizontal intercept, Px=0 and QDx=3200 and ηxx = 0.
Constant Price Elasticity Demand Curve
We just saw that elasticity varies along a linear demand curve. There is another form of
demand curve (which is frequently used in empirical work) on which elasticity remains
the same at each point. The functional form of the demand curve is already given in
Value Addition 1.1:
Qx = a(1/Pxb ),
where a and b are positive constants and b is the elasticity parameter.

Elasticity at any point on the demand curve is given by
ηxx = -(dQx/dPx)*(Px/Qx) = (ab/Pxb+1) *(Px/a.Px-b) .
After simplifying we get, ηxx = b.
Suppose a=100 and b=1, then Qx= 100/Px.
When Px=I, Qx=100 and ηxx= -(dQx/dPx)*(Px/Qx) = (100/Px2)*(1/100) =
(100/1)*(1/100) = 1=b.
When Px=4, Qx=25 and ηxx= (100/16)*(4/25) =1=b.
Thus the demand curve Qx=100/Px is an unit elastic demand curve. It is a rectangular
hyperbola. Such a demand curve is illustrated in Fig.1.v.1.
Suppose we assume a=100 and b=2, then Qx=100/Px 2.
If Px=2,Qx=25 and ηxx= -(dQx/dPx)*(Px/Qx) =
(200/Px3)*(2/25)=(200/8)*(2/25)=2=b.
Instead, if Px=5, Qx=4 and ηxx= (200/53)*(5/4)=(200/125)*(5/4)=2=b.
25
Thus, when b=2, the elasticity of demand is equal to two at each point on this demand
curve
(ii) Second, comparing two straight line demand curves of the same slope, the one
farther from the origin is less elastic at each price than the one closer to the origin.
In fig. 1.14, D1E1 and D2E2 are two parallel straight line demand curves. Let us take the
price P, A and B are the corresponding points on the demand curves D1E1 and D2E2
respectively. Since the two curves are parallel, is the same at points A and B. Price
is also the same. On the curve farther from the origin (D 2E2) quantity is larger (i.e., OQ2
> OQ1 ) and hence P/Q is smaller, thus elasticity is smaller.
Figure 1.14: Parallel Demand Curves
Reinfource Your Learning
Generally, elasticity is measured at a particular price and in that case, at each price,
elasticity on D2E2 will be less than the elasticity on D1E1. But if we measure elasticity at
a particular quantity, then we will get a different result. For example, elasticity at
quantity Q2, on the demand curve D1E1 is (∆Q/∆P).(CQ2/OQ2) and on the demand
curve D2E2 is (∆Q/∆P).(BQ2/OQ2). As BQ2 is more than CQ2, so, at the quantity Q2,
the demand curve D2E2 is more elastic than the demand curve D1E1 .
(iii) Third, of two intersecting straight line demand curves the steeper demand curve will
be less elastic than the flatter one at the point of intersection.
In fig. 1.15, D1 E1 and D2 E2 are two straight line demand curves intersecting at point A.
D1 E1 is steeper that D2 E2 . At the point of intersection A, P/Q is the same on the two
demand curves. On the steeper demand curve D1 E1, is larger than on the flatter
demand curve D2 E2; thus, the ratio is smaller on the steeper curve than on the
flatter curve, so that elasticity is lower.
26
Figure 1.15: Intersecting Demand Curves
Thus, if we take two intersecting straight line demand curves, the flatter demand curve
will show greater elasticity than the steeper one at a given price. But it is not always
true that a flatter demand curve will show greater elasticity than a steeper one. In fact,
if two straight line demand curves having different slopes start from the same point on
the price axis, the elasticities on the two demand curves will be the same at a given
price.
In fig. 1.16 DE1 & DE2 are two straight line demand curves starting from the same point
D on the price axis, DE1 beting the steeper one. At price P, elasticity of the demand
curve DE1 will be and of DE2, will also be Hence elasticity is the same at price P
on the two demand curves. Thus, a flatter demand curve does not necessarily signify a
greater elasticity than a steeper one.
Figure 1.16: Demand Curves Having The Same Vertical Intercept
IV. Total Expenditure and price elasticity When price of a good increases, the consumer
spends more on each unit of the good bought. At the same time she buys less units of
the good. If the price effect outweighs the quantity effect, the total expenditure on the
good rises. If the quantity effect outweighs the price effect, then total expenditure falls.
If the elasticity of demand is less than one, then a 1 per cent increase in price leads to
less than a 1 per cent decrease in quantity demanded and the price effect outweighs the
quantity effect leading to rise in the expenditure on the good.
If the elasticity exceeds one, a small increase in price causes a more than proportionate
fall in the quantity demanded, so the quantity effect dominates and total expenditure
falls. If the elasticity is equal to one, a given percentage increase in price leads to an
equal percentage fall in the quantity bought and the total expenditure remains the same.
In general, if η < 1, then the change in price and the change in total expenditure move
in the same direction; if η > 1, then the change in price and the change in total
expenditure move in the opposite directions and if η = 1, with a change in price, the
total expenditure remains the same. It is clear that, the money spent by purchasers of a
27
good is received by the sellers. The total expenditure on the good by the consumers is
thus the total revenue for the sellers. Thus the previous relationship also holds good
between elasticity and total revenue. This relationship can be formally proved as follows:
Total revenue = TR = P × Q
Differentiating TR with respect to price, we get,
So when ηxx <1, then=""> 0; that is, total revenue and price move in the same
direction. When ηxx >1, then< 0; that is, total reveune and price move in opposite
directions. When ηxx =1, then= 0; that is, with a change in price there is no change in
total revenue.
Example : Using only the total expenditure criterion, determine if the demand
schedules given in the following table are elastic, inelastic, or unitary elastic.
Price 5 4 3 2 1
(in Rs.)
Qx 120 150 200 300 600
Qy 120 160 225 350 725
Qz 120 140 175 250 475
Ans.
Price Qx TEx Qy TEy Qz TEz

(in Rs.) (in Rs.) (in Rs.) (in Rs.)
5 120 600 120 600 120 600
4 150 600 160 640 140 560
3 200 600 225 675 175 525
2 300 600 350 700 250 500
1 600 600 725 725 475 475
28
(i) For good X, as the total expenditure on the good remains the same at Rs.600, so the
demand for X is unitary elastic.
(ii) For good Y, the total expenditure on the good is rising with a fall in the price. That is,
price and total expenditure are moving in the opposite direction, so the demand is
relatively elastic.
(iii) In case of good Z, with a fall in the price total expenditure also falls. So the demand
is relatively inelastic.
Applying the Theory
Relationship Between Revenue and Elasticity

Source: http://www.uri.edu/INT1/Mic/Elast/index.elast.html
The link between elasticity and revenue may answer the following questions: Why would
Brazil, one of the world's largest producers of coffee, burn some of their coffee harvest
as a way of increasing the value of coffee exports? Why would the OPEC countries lower
production if their goal was greater income? Why does agricultural income fall in years of
a good harvest?
In the coffee example, what could we expect when Brazilian officials reduce the supply of
coffee? Coffee drinkers seem to need their coffee and they can be expected to pay
whatever they need to pay to get their coffee fix. In this situation the reduction in supply
will lead to a substantial increase in price as the demanders compete for the smaller
supply. The net effect on revenue will be positive with the increase in price ( P) more
than compensating for the decreased quantity ( Q).
The relationship between elasticity and total revenue can be explained in the following
way. Let's assume there is an increase in supply - the supply curve shifting to the right.
Total revenue is by definition equal to the price times the quantity sold (P*Q). In the
diagrams below the initial situation is described by the black supply curve (inner curve).
The revenue earned from selling the output is the areas A + B. After the increase in
supply shifts the supply curve to the right (red line), revenue equals the area B + C.
Revenue will increase as a result of the increase in supply if (area C) > (area A). In the
diagrams below we see that this happens when the demand curve is flat - when demand
is elastic. When demand is elastic, revenue will increase if we decrease the price or
increase supply. Revenue and output move in the same direction while revenue and
price move in opposite directions when demand is elastic. When demand is inelastic,
revenue will decrease if we decrease the price or increase supply. Revenue and output
move in opposite directions while revenue and price move in the same direction when
demand is inelastic.
Guidelines
We can now come up with some guidelines that tell us what to do with price or output if
our goal is to raise revenue. The general rules appear below.
Inelastic Demand | ep | < 1
 Output and revenue are negatively related: to raise revenue you would lower
output
 Price and revenue are positively related: to raise revenue you would raise price
29
Elastic Demand | ep | > 1
 Output and revenue are positively related: to raise revenue you would raise
output
 Price and revenue are negatively related: to raise revenue you would lower price
To understand the relationship between elasticity and revenue, let's look at the dilemma
faced by OPEC countries.The OPEC countries once controlled the supply of oil and they
were meeting to decide what to do about their levels of oil production. Some wanted to
raise output while others wanted to lower output. The strategy to lower output would be
most effective when:
a. income elasticity of demand was high

b. cross price elasticity was low
c. price elasticity of demand is low
d. price elasticity of supply is high
Let's begin with the basics - Revenue = P*Q. The change in revenue will depend upon
the changes in price and quantity. The decision to restrict output (decrease in Q) as a
means to increase revenue works when we have reason to believe that revenue and
output tend to move in opposite directions (Revenue increases when Quantity falls). If
we cut production, the only way that this will increase revenue is if the price rises
substantially. This will happen if we are talking about a product where price does not
have much of an effect on demand - a product where demand is inelastic.
Now let's look at the previous graph. Because demand is inelastic, the curve is steep so
the appropriate diagram is the one on the right. The original equilibrium is where the
supply curve and demand curve intersect [price = P1 and the quantity = Q1]. Total
revenue is equal to the area A + B. If the supply is increased, the supply curve shifts
out, then the new equilibrium will generate revenue equal to the area B + C. If we
compare the revenues we see that the decision to expand output will lower revenue
when demand is inelastic. In this case, if OPEC thought that demand was inelastic, the
group should agree to restrict output which is exactly what they did.
With the help of the previous graph we can explain how good news for farming can be
bad news for farmers. Generally demand curve for agricultural products is fairly inelastic,
so the appropriate diagram is the one on the right panel. When an improvement in the
farm technology or a favourable weather condition shifts the supply curve of, say, wheat,
from S to S’, price falls steeply but demand increases only slightly and total revenue
falls.
Solved Problem
Question : Suppose the price of a good is Rs.10 and its demand elasticity at this price
is 0.5. Suppose that due to a rise in its price its demand fallls by 10 percent. What is the
new price? What happens to the total expenditure on the good after a rise in its price?
Calculate the percentage change in the total expenditure.
Answer: We know that ηxx = (percentage change in quantity/ percentage change in
price).
So, (0.5) = 10/ (∆P/P) .100 =10 P/ 100.∆P =10*10/ 100*∆ P =1/ ∆ P
Or, ∆ P = 2.
So the new price is Rs. 12.
As the elasticity of demand is less than one , so total expenditure on the good will rise
with a rise in the price.
30
The percentage change in total expenditure can be written as: {(P 2Q2 - P1Q1)/ P1Q1}
*100
={ (P2Q2/ P1Q1 ) – (P1Q1 /P1Q1) }* 100
= { (P2/P1).(Q2/Q1) – 1 }* 100. (I)
Now, we know that { (Q2 – Q1 )/ Q1 }* 100 = -10.
Therefore, { ( Q2 /Q1 ) - 1 } = -1/10,
Or, (Q2/Q1 ) = 9 / 10.
Putting this value in ( I ), we get the percentage change in total expenditure as:
{ (12 /10 ) . (9 / 10 ) – 1 } * 100
={ ( 108 – 100 ) / 100 } * 100
=8.
V. Factors affecting price elasticity The size of the price elasticity of demand depends on
the following factors.
(i) First, the price elasticity of demand for a good is larger the closer and the greater are
the number of substitutes available. For example, the demand for oranges is more
elastic than the demand for salt because oranges have closer and more number of
substituts (like banana, mango, etc.) than salt. Thus, if the price of both salt and orange
rise by the same percentage decrease in the demand for orange will be more than that
for salt.
We know that the more narrowly a good is defined, the larger are the number of
substitutes available and hence elasticity of demand also will be larger. For this reason
the demand for a particular brand of a product will be more elastic than the product in
general. For example, the detergent brand ‘Surf’has many substitutes like ‘Ariel’, ‘Tide’,
‘Nirma’etc. and hence an increase in the price of Surf will induce the consumers to buy
other brands and therefore, the demand for Surf will reduce to a great extent. Whereas,
if the price of detergent powder in general increases then the demand for it will not
reduce to a great extent because close substitutes are not available for it. Thus, demand
for Surf will be much more elastic than the ‘detergent powder’ in general.
In the extreme case, if a good is defined so that it has perfect substitutes, its elasticity
of demand is infinite. For example, if a particular petrol pump charges a higher price for
petrol than the market price, then it would lose all customers, as buyers will switch over
to other petrol pumps which are selling idential products at the market price.
(ii) Second, the elasticity of demand depends on the nature of the need that the good
satisfies. In general, luxury goods are price elastic, while necessaries are price inelastic.
For example, goods like cereals, cooking gas, sugar, salt, potatoes, electricity, transport
to and from the place of work are necessities and with a rise in their price quantity
demanded will not be recduced significantly. Whereas, goods like entertainments, eating
out, holidaying, etc. are luxuries and their demand will be price elastic.
(iii) The proportion of income spent on a good is another factor determining its elasticity.
Higher the proportion more is the price elasticity of demand. Examples are durable
goods like electrical appliances, cars etc. Whereas a consumer spends a very small
proportion of her income on the purchase of goods like salt, vegetables, milk etc., and
their demand will be price inelastic.
(iv) Another factor is the time period over which the consumers adjust to a price change.
The longer the adjustment period the more will be the elasticity of demand. For
example, immediately after a rise in the price of LPG, a household may not be able to
reduce its demand for it but in the longer run it will be able to replace LPG by either
piped natural gas or electricity and hence demand for LPG will decrease. So demand for
LPG will be more elastic in the long run than in the shortrun.
31
VI. Average Revenue, Marginal Revenue and Elasticity of Demand

The market demand curve shows for each specific price the quantity of the good that
buyers will buy.
In fig.1.17, point A on the market demand curve DD′ shows that at the price of OP per
unit, the quantity demanded by the buyers or quantity sold by the sellers is OQ. Total
revenue is equal to the price per unit of the good times the quantity of the good sold.
From the stand point of sellers OP×OQ or the area of the rectangle OPAQ is the total
revenue obtainable when a price of OP per unit is charged.
Average revenue (AR) is the revenue per unit of output sold. That is,
Where Q is the quantity sold at the price P. Thus, AR is identically equal to price. In Fig.
1.17, when quantity sold is OQ, price as well as average revenue is equal to AQ which is
the height of the demand curve corresponding to OQ. So the market demand curve can
be considered as the AR curve from the point of view of the seller.
Marginal revenue (MR) is the change in total revenue attributable to a one-unit change
in output sold. In general, MR is calculated by dividing the change in TR by the change in
output. That is,
where, ΔTR is the change in TR and ΔQ is the change in output. In particular, when ΔQ =
1, MR = ΔTR. In equation (1.15) the changes are finite. For infinitesimally small change
in quantity and revenue,
or, Marginal revenue at any point on the TR curve is given by the slope of the total
revenue curve at that point.
32
Calculation of Marginal Revenue
The first two columns in Table 1.8 give the demand schedule of the good. Column 3 is
derived by multiplying columns (1) & (2), and it gives us total revenue. The change in
total revenue resulting from each additonal unit of the good sold gives the marginal
revenue which is shown by column 4. Because average revenue is identically equal to
the price of the good so column 1 also gives us the AR.
Table 1.8. Calculation of Total Revenue and Marginal Revenue

(1) Price (P) (2) Quantity (Q) (3) (4)
(in Rs.) (in units) Total Revenue Marginal Revenue (MR)
(TR) (in Rs.) (in Rs.)
9 0 0 –
8 1 8 8
7 2 14 6
6 3 18 4
5 4 20 2
4 5 20 0
3 6 18 –2
2 7 14 –4
1 8 8 –6
The information given in Table 1.8 is plotted
In fig.1.18. Panel (a) gives the total revenue curve which is drawn by plotting the points
given in columns (2) and (3), and then joining these points by straight line segments.
This is done because the data given in the table is discrete. The TR curve rises steadily
till 4 units of the good are sold, remains constant at Rs.20 between 4th and 5th unit and
then declines. Panel (b) gives the corresponding demand (AR) and marginal revenue
curves. Points on the TR and D curves are plotted at each level of output.
Figure 1.18: Derivation Of AR And MR Cuver From TR Cuver
For example corresponding to 1 unit of output sold, P or AR = Rs.8 and TR = Rs.8.

Similarly, corresponding to 2 units of output sold price = AR = Rs.7 and TR = Rs.14 etc.
But points on the marginal revenue curve are plotted at the mid point of each quantity
interval. For example marginal revenue of Rs.8 corresponds to 0.5 unit of output sold
and MR of Rs.6 corresponds to 1.5 units of quantity sold which do not tally with the data
given in Table 1.18. MR curve is drawn in this way because the example upon which the
graph is based contains discrete data. As is already mentioned, the TR curve is obtained
by connecting the various points by straight-line segments. For example, between 0 and
1 unit of output the TR curve is a straight line and hence the corresponding MR is
constant at Rs.8 between 0 and 1 unit of output. Similarly, MR is constant at Rs.6
between 1 unit and 2 units of output etc. Thus, to be exactly correct the MR curve
33
should be drawn as a step-decrcasing function rather than as a continuous function. To

compensate for this incon- sistency, the values of MR are plotted at the mid point of
each quantity interval.
In this discrete example, AR = MR at quantity 1 and price Rs. 8. In a continuous case,

the two are equal when they are infinitesimally close to the vertical axis. It should also
be clear from the table that as long as TR is rising MR is positive, when TR is declining
MR is negative and MR is equal to zero when TR is maximum. In the table TR remains
constant between 4 and 5 units of output, so in panel (b) of fig. 1.18. MR is shown to be
equal to zero corresponding to 4.5 units of output.
When demand curve is a downward sloping straight line, we can easily derive the
corresponding MR curve.
Let the inverse demand function be given by
P = a – b Q, (1.17)
Where a is the intercept and –b the slope of the demand curve.

Then TR = P×Q = aQ – bQ2 (1.18)
and MR =
From equation (1.19) we can derive two important relationships between MR and the
demand curves when the demand curve is a downward sloping straight line. The MR
curve has the same intercept as the demand curve and a slope which is twice as large in
absolute value as the slope of the demand curve. Equation (1.19) can be rewritten as
follows :
MR = a – bQ – bQ = P – bQ (1.20)
As b is a positive constant, so for any positive value of Q, MR will be less than the price.
When Q = 0, MR will be equal to the price.
In general, the marginal revenue is given by
where is the slope of the demand curve at the relevant point. When the demand
curves are negatively sloped is negative, and hence, MR is less than the price. When
the demand for a good is perfectly elastic and the demand curve is horizontal, = 0,
and hence, MR will be equal to the price.
Thus, MR curve lies below the demand curve when the latter has a negative slope. The
reason is that to sell more units the price must be lowered, not just on the last unit, but
on all previous (or intra-marginal) units as well 1. For example, in Table 1.18, to increase
34
quantity sold from, 2 to 3 units, price is reduced from Rs.7 to Rs.6 per unit. Therefore,
the MR on the 3rd unit of the good is given by the current price Rs.6 minus the Re1
reduction in price for the previous two units. So MR on the 3rd unit is given by Rs.6 –
Rs.2 = Rs.4, which is lower than the price of Rs.6.
For a given quantity, price measures the height of the demand curve. Since MR < P, so
MR curve is below the demand curve.
Solved Problem
Question: Given the demand function Qx = 100-10Px, derive the equations for TR,
AR and MR functions. On the basis of your answer derive the relationship between AR
and MR.
Answer: First, we will derive the inverse demand function Px=f(Qx).

Rearranging the demand function, we get,
Px = 10-(1/10)*Qx. (i)
Multiplying (i) by Qx, we get,
TR = Px*Qx = 10Qx-(1/10)*Qx2 (ii)
Differentiating (ii) w.r.t. Qx, we get,
MR = 10-(1/5)*Qx. (iii)
Equations (i) and (iii) give us the AR and MR functions respectively.
The AR curve has a constant slope of –(1/10), implying that it is a downward sloping
straight line. Further, it has a vertical intercept equal to 10.
From (iii) it is clear that the MR curve also has the same vertical intercept as the AR
curve (10). Its slope is –(1/5), which is twice as much as the slope of the AR curve in
absolute term.
For any quantity, AR>MR. For example, at Qx=20, AR=Px=8 and MR=10-(1/5)*20 = 6;
at Qx=50, AR=Px=5 and MR= 10-(1/5)*50 =0; at Qx=80, AR=Px=2, and MR = 10-
(1/5)*80 = -6.
This illustrates that the MR curve lies below the demand curve (i.e., the AR curve) when
the demand curve is a downward sloping straight line.
The Geometry of Marginal Revenue Determination
We can use the relationship given in equation (1.21) to construct the marginal revenue
curve corresponding to a given demand curve. This is shown in fig.1.19 where in panel
(a) the demand curve is linear and in panel (b) it is non-linear. In panel (a), we can find
marginal revenue corresponding to point E on the demand curve Dx by dropping
perpendicular EA to the vertical axis and EC to the horizontal axis. We know from
equation (1.21) that MR = P+Q Corresponding to point E, P = OA and Q = OC = AE
35
and Therefore, Q = – AD. So MR = OA – AD = Rs.6 – Rs.3 = Rs.3. This is

shown as point E′. Similarly, it can be derived that MR corresponding to point F on the
demand curve Dx is OG – GD = 4.5 – 4.5 = Rs.0. This is shown as point F′. By joining E′
and F′ with a straight line we derive the marginal revenue curve MRx corresponding to
the demand curve Dx. It should be noted that the marginal revenue curve MRx starts at
point D from where the demand curve Dx also starts and it bisects any perpendicular
drawn from the demand curve to the vertical axis. For example, AK = AE and OF′
ODx. We can prove this as follows. We know that the slope of the MR curve is twice as
much as the slope of the demand curve when the demand curve is linear.
In Fig. 1.19(a), slope of MR curve =(OD/OF’) and slope of the demand curve
=(OD/ODx).
Thus, (OD/OF’)=2(OD/ODx). So, OF’= (ODx/2).
This gives another way to derive the MR curve geometrically corresponding to a linear
demand curve.
Figure 1.19:Relationship between AR And MR Curves
To find the marginal revenue corresponding to any point on a non-linear demand curve,
we draw a tangent to the demand curve at that point and then proceed as described
above. For example, to find the MR corresponding to point E on the non-linear demand
curve D′x given in pannel (b) of fig.1.19, we draw the tangent AB and then drop
perpendicular EG to the vertical axis and EL to the horizontal axis. Following equation
(1.21), we can prove that the MR corresponding to point E will be OG – AG = Rs. 10 –
Rs.5 = Rs.5. This is shown as point E′. Similarly, corresponding to point F on the
demand curve Dx′, MR will be equal to zero which is shown as point F′. Joining points
like E′, F′ we get the marginal revenue curve MR′x corresponding to the nonlinear
demand curve D′x.
36
Marginal Revenue, Price and Elasticity
The marginal revenue is related to the price and the elasticity of demand by the
following formula
For a downward sloping straight line demand curve the relationship (1.23) is shown in
fig.1.20. On the demand curve DD’, M is the mid-point and hence η = 1 at that point.
Corre- sponding to point M on the demand curve, MR = O and the MR curve intersects
the quantity axis. For any point above M on the demand curve, η > 1 and hence MR > 0
For example, at point K on the demand curve, P = KC and MR = BC.
Figure 1.20: Relationship Between AR and MR Curves
37
For any point below M on the demand curve, η < 1, and hence MR < 0, e.g., at point L,
η < 1 and MR curve goes below the quantity axis.
For an unitary elastic demand curve, elasticity is equal to one at every point on the de-
mand curve and hence MR = 0 for every level of output. In fact, an unitary elastic
demand curve has the shape of a rectangular hyperbola and its corresponding MR curve
will merge with the horizontal axis. A rectangular hyperbola is a downward sloping
curve which is asymptotic to both the axes and the areas of the rectangles formed under
the curve are equal.
In fig. 1.21 let DD’ be a unitary elastic demand curve. Then at every point on the
demand curve total revenue remains the same. Total revenue at point A on the demand
curve is given by the area of the rectangle OP AQ . Similarly, total revenue at points B
and C on the demand curve are given respectively by the arof OP 2 BQ2 and OP3 CQ3 .
Thus area of OP1 AQ1 = area of OP2 BQ2= area of OP3 CQ3. Hence, the demand curve DD’
is a rectangular hyperbola and since MR = 0, whenever η = 1, so MR curve merges with
the quantity axis.
Figure 1.21: Unitary Elastic Demand Curve
1.2.1(b) Cross-price Elasticity of Demand
The cross-price elasticity of demand measures the relative responsiveness of quantity

demanded of a given good to changes in the price of another good. In other words, it is
the proportionate change in the quantity demanded of a good X divided by the
proportionate change in the price of another good Y. Thus,
ηxy = (1.24)
where ηxy = cross price elasticity of demand between good X and good Y,
Δ Q x = change in the quantity demanded of X,
ΔPy = change in the price of Y.
When goods X and Y are substitutes of each other, a rise in the price of Y will lead to an
increase in the demand of X and hence, > 0 and, therefore, ηxy > 0.
On the other hand, if goods X and Y are complements of each other, then a rise in the
price of Y will lead to a reduction in the quantity demanded of Y and also a reduction in
the demand of X. Thus, < 0 and hence ηxy will be negative.
38
If X and Y are not related to each other, so that a change in the price of Y does not
cause any change in the quantity demanded of X, then ηxy = 0.
It should be noted that the value of ηxy need not be equal to the value of ηyx because
the responsiveness of quantity demanded of X with respect to a change in the price of Y
need not equal the responsiveness of quantity bought of Y to a change in price of X.
If the goods X and Y are produced by two firms belonging to the same industry, then X
and Y will be substitutes of each other and their cross price elasticity will be a large
positive number. For example ‘Tropicana’ and ‘Real’ belong to the same packaged fruit
juice industry and a rise in the price of one will lead to a rise in the quantity demanded
of the other and so they will have a high positive cross price elasticity. Thus, high
positive cross elasticities among a group of commodities is frequently used to define the
boundaries of an industry. If the cross price elasticity among a group of goods equals
zero or is negligible, then the goods will belong to different industries rather than to the
same industry.
Example : Find the cross elasticity of demand between Coffee (X) and Tea (Y) and
between Coffee (X) and Milk (Z), for the data given in Table 1.9. Also interprete your
results.
Table 1.9
Good Before After
Pric Quantity Price Quantity
(Rs. unit) (units/month) (Rs./unit) (unit/month)
Tea (Y) Rs. 250/kg. 0.5 kg./month Rs.500/kg. 0.25 kg./month
Coffee (X) Rs. 500/kg. 0.2 kg./month Rs.500/kg. 0.3 kg./month
Milk (Z) Rs. 15/litre 60 litres/month Rs.18/kg. 45 litres/month
Coffee (X) Rs. 500/kg. 0.2 kg./month Rs.500/kg. 0.1 kg./month
Ans. ηxy = .
Since ηxy is positive so tea and coffee are substitutes of each other.
Now, ηxz =
Since ηxz is negative coffee and milk are complements of each other.
A Brain Teaser
Sppose that the cross price elasticity of demand for two goods is minus infinity. What
would you infer about the two googds?
39
Applying the Theory
Source:http://tutor2u.net/economics/revision-notes/as-markets-
crossprice-elasticity-of-demand.html
How can businesses make use of the concept of cross price elasticity of demand?
Pricing strategies for substitutes: If a competitor cuts the price of a rival product, firms
use estimates of cross-price elasticity to predict the effect on the quantity demanded and
total revenue of their own product. For example, two or more airlines competing with
each other on a given route will have to consider how one airline might react to its
competitor’s price change. Will many consumers switch? Will they have the capacity to
meet an expected rise in demand? Will the other firm match a price rise? Will it follow a
price fall?
Consider for example the cross-price effect that has occurred with the rapid expansion of
low-cost airlines in the European airline industry. This has been a major challenge to the
existing and well-established national air carriers, many of whom have made
adjustments to their business model and pricing strategies to cope with the increased
competition.
Pricing strategies for complementary goods: For example, popcorn, soft drinks and
cinema tickets have a high negative value for cross elasticity– they are strong
complements. Popcorn has a high mark up i.e. pop corn costs pennies to make but sells
for more than a pound. If firms have a reliable estimate for cross price elasticity of
demand they can estimate the effect, say, of a two-for-one cinema ticket offer on the
demand for popcorn. The additional profit from extra popcorn sales may more than
compensate for the lower cost of entry into the cinema.
Advertising and marketing: In highly competitive markets where brand names carry
substantial value, many businesses spend huge amounts of money every year on
persuasive advertising and marketing. There are many aims behind this, including
attempting to shift out the demand curve for a product (or product range) and also build
consumer loyalty to a brand. When consumers become habitual purchasers of a product,
the cross price elasticity of demand against rival products will decrease. This reduces the
size of the substitution effect following a price change and makes demand less sensitive
to price. The result is that firms may be able to charge a higher price, increase their total
revenue and turn consumer surplus into higher profit.
Relationship between Own–and Cross-Price Elasticities
Own-price and cross-price elasticities of demand are somewhat dependent on each

other. Let us suppose that a consumer spends her entire income on the purchase of just
two goods X and Y. If the consumer’s own-price elasticity of demand for good X is less
than one, then with a rise in the price of X, ceteris paribus, the total expenditure on X
will increase. Assuming no change in the consumer’s income, this will imply that
expenditure on good Y will decrease. As price of Y is assumed to remain constant, this
would indicate a reduction in the quantity bought of Y. So a rise in the price of X leads to
a fall in the quantity demanded of Y, implying that X and Y are complements. Thus if
own-price elasticity is less than one, then the cross price elasticity is negative. Similarly
it can be derived that if the own-price elasticity exceeds one, then the cross-price
elasticity will be positive and the two goods will be substitutes of each other.
These relationships can be extended to the case when the consumer consumes any
number of goods : If the own-price elasticity of demand for good X exceeds one, then in
some average sense, the other goods are substitutes for X. If the own-price elasticity is
less than one, then in that same sense, the other goods are complements. This
proposition can be formally derived as follows :
40
Let the consumer spend her income, I, on the purchase of n goods. Then her budget
constraint is given as :
I = P1Q1 + P2Q2 + --- + PnQn, (1.25)
where Pi is the price of good i and Qi the quantity consumed of good i.

Let there be a change in P1, prices of other goods and income of the consumer remaining
constant. Differentiating (1.25) with respect to P1, we get,
[as I & P2, ...., Pn are constants]
Dividing the equation throughout by Q1 , we get,
Multiplying and dividing the 2nd to nth terms on the R.H.S. of the previous equation by
(P1/Qj), j=2,3,...,n, we get,
where η11 is the own-price elasticity of demand for good 1; ηj1 is the cross-price
elasticity between the jth good and good 1; E 1 is the expenditure on good 1 and Ej is the
expenditure on the jth good, j = 2, ..., n.
The R.H.S. of equation (1.26) gives us the weighted sum of the cross-price elasticities
between good 1 and other goods. Equation (1.26) implies that if η 11 > 1, then this
weighted sum of cross-price elasticities will be positive indicating that on an average, the
other goods are substitutes for good 1. On the other hand, if η 11 < 1, then the weighted
sum of cross-price elasticities will be negative implying that in some average sense the
other goods are complements of good 1.
41
Applying the theory
Question: Suppose a consumer spends her entire income on the purchase of two
goods, X and Y. Suppose further that the consumer’s own price elasticity for X was more
than one. Then prove that X and Y are substitutes.
Solution: Let Px and Qx be the price and quantity bought of X respectively, and Py
and Qy be the price and quantity of good Y. Let I be the income of the consumer.
As the consumer is spending her entire income on the two given goods so,
I= Px. Qx + Py .Qy (i)
Let there be a change in the price of X, income of the consumer and price of Y remaining
constant. Thus, differentiating (i) with respect toPx we get
or,0 = 1- ηxx + ηyx,
or, ηxx – 1 = ηyx. (ii)
It is clear from equation (ii) that if ηxx >1, then ηs >0, implying that goods X and Y are
substitutes of each other.
1.2.1(c) Income Elasticity of Demand
The income elasticity of demand refers to the relative responsiveness of demand of a

good to changes in consumer’s income. In other words, it is the proportionate change in
demand divided by the proportionate change in money income of the consumer.
Symbolically,
where, ηI is the income elasticity,
ΔQx is the change in the quantity bought of good X,
ΔI the change in income,
Qx the original quantity, and I the original income.
If X is a normal good for the consumer then with a change in her income the quantity
demanded of X will change in the same direction and so > 0 and hence ηI will be
positive. If X is an inferior good then ηI will be negative. A normal good can be further
classified as a necessity if ηI is less than one and as a luxury if ηI is greater than one.
Most of the broadly defined goods such as food, fuel, housing, education, clothings etc.
are normal goods, while narrowly defined inexpensive goods such as coarse rice, jawar,
bajra, vanaspati, synthetic clothes, 555 detergent powder etc. are usually considered as
42
inferior goods. Among normal goods, food, fuel, clothings etc. are necessities while
higher education and housing are luxuries.
Reinforce you learning
It should be kept in mind that this classification of goods into normal and inferior, and
necessity and luxury is not strictly defined. In fact, the same good can be regarded as a
luxury by some individuals and as a necessity or even an inferior good by other
individuals. Even the same individual might consider a good as a luxury at a lower level
of income, as a necessity at intermediate level of income and as an inferior good at high
level of income.
Example : From the income quantity relationship given in Table 1.10, find the income
elasticity of demand between the various successive levels of income and determine over
what range of the consumer’s income the good is a luxury, a necessity, or an inferior
good for the consumer.
Table 1.10
Point A B C D E F
Income 2,000 4,000 6,000 8,000 10,000 12,000
(Rs./month)
Quantity 100 300 500 650 700 600
(Kg/month)
Ans. (i) Income elasticity between A and B
= 2. As ηI > 1, between A and B the good is a luxury.
(ii) ηI between B and C
As ηI >1, so between B & C the good is a luxury.
(iii) ηI between C and D
As ηI <1, so the good now is a necessity for the consumer.
43
(iv) ηI between D and I,
So the good is a necessity
(v) ηI between E and F,
Since ηI is negative so the good has now become an inferior good for the consumer.
It can be shown that if a consumer’s income elasticity of demand for a particular good is
greater than one, then with a rise in the consumer’s income, the proportion of income
spent on the good will increase. The opposite will take place if the ηI is less than one. If
ηI = 1, then with a rise in income, the proportion of income spent on the good will
remain the same.
Let us suppose that at income I, the individual consumes Qx units of the good at a price
of Px/unit and with a rise in income by ΔI, cetris paribus, she consumes ΔQx more units
of X.
Before the change in income the proportion of income spent on X is Pr1 = .

(1.28)
44
From (1.30) it is clear that if ηI > 1, then > 1, i.e., the proportion of income spent
on good X will increase with a rise in income. Similarly, if η I < 1, the proportion of
income spent on X will decrease and if ηI = 1, then Pr2 = Pr1, implying that proportion of
income spent on X will remain the same with a rise in income.
Learn more about Income Elasticity of Demand
A well known result involving the income elasticity of demand is that the weighted sum
of all income elasticities is equal to unity. It can be proved as follows.
Let the consumer spend all her income, I, on n goods whose prices are given as P 1, P2,
..., Pn. Let Q1, Q2,...,Qn be the quantity consumed of the n goods respectively. Then the
budget constraint can be written as:
I = P1Q1+P2Q2+...+PnQn (i)
45
Let there be a change in the income of the consumer, prices of all the goods remaining
constant. The effect can be shown by partially differentiating (i) with respect to I.
Thus, (δI/δI) = P1 (δQ1/δI) + P2 (δQ2/δI) + ...+Pn (δQn/δI).
Multiplying and dividing the previous equation by (I/Qj) j = 1,2,...,n, we get,

1=P1(δQ1/δI)*(I/Q1)*(Q1/I)+P2(δQ2/δI)*(I/Q2)*(Q2/I)+...+Pn (δQn/δI)*(I/Qn)*(Qn/I).
Rearranging the terms, we get,
1=[(δQ1/δI)*(I/Q1)]*(P1Q1/I)+[(δQ2/δI)*(I/Q2)]*(P2Q2/I)+…+[(δQn/δI)*(I/Qn)]*(PnQn/I)
Or, 1 = ηI1(E1/I) + ηI2(E2/I) +...+ ηIn(En/I),
where, ηIj is the income elasticity of jth good and Ej is the total expenditure on the jth
good, j = 1,2,...n.
or, 1 = ηI1 λ1 + ηI2 λ2 + ...+ ηIn λn,
where, λj is the proportion of income spent on the jth good. It is clear that, λ 1+λ2+...+
λn = 1.
Hence, it is proved that the weighted sum of income elasticities is equal to one where
the proportion of income spent on the respective goods serve as the weights.
An interesting implication of this result is that in a world of n commodities that a
consumer consumes, there has to be at least one normal good. In other words, all goods
cannot be inferior goods
1.2.2 ELASTICITY OF SUPPLY
Elasticity of supply measures the responsiveness of the quantity supplied of a good with
respect to a change in its own price with every thing else held constant. Algebraically,
elasticity of supply (ηs) is the proportionate (percentage) change in the quantity supplied
of a good divided by the proportionate (percentage) change in the price of the good.
Thus,
where, ΔQx is the change in quantity supplied of good X,
ΔPx the change in the price of X, Px the original quantity,

and Qx the original price.
For infinitesimally small change in price and quantity, the formula for elasticity is given
by (1.32)
where, is the inverse of the slope of the supply curve at the point where price is
given by Px and quantity supplied Qx.
46
Thus, equation (1.32) gives us the elasticity at a point on the supply curve. Just like the
elasticity of demand, the arc elasticity of supply gives us the elasticity between two
points on the supply curve and can be given by slightly modifying the formula (1.31).
Thus,
Arc elasticity
where Px1 & Qx1 are original price and quantity and Px2 & Qx2 are new price and
quantity. If the supply curve of a good is upward sloping the coefficient of elasticity of
supply will have a positive sign. The supply curve is said to be elastic if η s > 1, inelastic if
ηs > < 1, and unitary elastic if ηs > = 1. It should be noted that for a positively sloped
supply curve, an increase in the price will always lead to an increase in the total revenue
of the seller and vice-versa.
The elasticity of supply depends on the period of time allowed for adjustment. As
adjustment in supply is easier in the long run than in the short run, so supply of a good
will be more elastic in the long run than in the short run.
1.2.2 (a) When the supply curve is a positively sloped straight line crossing the price
axis, then all along the line, ηs > 1.
In fig. 1.22, SSx is a linear supply curve. Point A on the supply curve corresponds to
price P1 and quantity Q1. Elasticity of supply at point A on supply curve is given by
Figure 1.22: Supply Curve
47
Similarly, we can prove that at any other point on the supply curve η s > 1.
1.2.2 (b) When the supply curve is a positively sloped straight line passing through the
origin, then all along the line, ηs = 1.
In fig. 1.23 OSx is the supply curve. Elasticity of supply at any point A on the curve is
given by
Figure 1.23: Supply Curve
1.2.2 (c) When the supply curve is a positively sloped straight line crossing the
quantity axis then ηs < 1.
In fig. 1.24, elasticity of supply at point A on the supply curve SSx is given by
1.2.2 (d) When the supply curve is curvilinear the elasticity of supply at any point on
the curve can be determined by drawing a tangent to the curve at that point and
proceeding in the manner as we had done for a linear supply curve. If the tangent
crosses the price axis, then ηs > 1, if it crosses the origin, then ηs = 1 and if it crosses
the quantity axis then ηs < 1. ηs at point A1 on the curve given in fig. 1.25 is greater
than one, at point A2, ηs is equal to one and at point A3 it is less than one.
48
Figure 1.25: Non Linear Supply Curve
Summary
1. Demand-supply analysis is an economic model of price determination in a
market.
2. The demand schedule, depicted graphically as the demand curve, represents
the amount of some good that buyers are willing and able to purchase at various
prices, assuming all determinants of demand other than the price of the good in
question, such as income, personal tastes, the price of substitute goods, and the
price of complementary goods, remain the same. Following the law of demand,
the demand curve is almost always represented as downward-sloping, meaning
that as price decreases, consumers will buy more of the good.
3. Price of the good concerned remaining the same a change in the price of
substitutes and/complements and a change in the consumer’s income leads to a
shift in the demand curve.
4. The supply schedule, depicted graphically as the supply curve, represents
the amount of some good that producers are willing and able to produce and sell
at various prices, ceteris paribus, that is, assuming all determinants of supply
other than the price of the good in question, such as technology and the prices of
factors of production, remain the same.
5. When factors other than own price of the good, such as prices of the inputs
and/technology change, the supply curve shifts.
6. Equilibrium is arrived in a competitive market at that price which equates the
quantity demanded of a good to quantity supplied. It occurs at the intersection of
the demand and supply curves.
7. Elasticity of demand measures the responsiveness of the quantity demanded
of a good to a change in the factors which affect demand.
8. Own price elasticity of demand is given by the percentage change in the
quantity demanded of a good divided by the percentage change in its price. Arc
elasticity measures elasticity between two points on the demand curve and Point
elasticity measures elasticity at a specific point on the demand curve. Price
elasticity of demand for a good will be higher the larger the number of substitutes
available and the longer the time allowed for demand to adjust to a change in its
price.
9. Cross price elasticity is given by the percentage change in the demand of a
good divided by the percentage change in the price of some other good. In case
the two goods are substitutes cross price elasticity is greater than zero and if they
are complements it is less than zero.
10. Income elasticity is given by the percentage change in the quantity bought of a
good divided by the percentage change in the consumer’s income. For normal
goods the coefficient of income elasticity is positive and for inferior goods it is
negative.
11. Elasticity of supply is given by the percentage change in the quantity sold
of a good to a given percentage change in the price of the good.
49
Exercise
1. 1. Use supply and demand curves to illustrate how each of the following events would
affect the price of butter and the quantity of butter bought and sold: (a) an increase in
the price of its substitute margarine; (b) an increase in the price of milk; (c) a decrease
in average income levels.
1. 2. Suppose the demand curve for a good is given by Qx = 10 – 2Px, where Px is the
price of good.. Determine the own price elasticity of demand for good X at Px = Re 1 and
Px = Rs. 2.
1. 3. Explain the following statements :
a. The individual’s demand curve for a good represents a maximum boundary of the
individual’s intentions
b. A producer’s positively sloped supply curve for a good represents in one sense a
maximum and in another sense a minimum boundary of the producer’s
intentions.
1. 4. Distinguish between a “substitute” and a “complement” of a good.

What will happen to the demand for a good X when prices of both a substitute and a
complement of X rise simultaneously?
1. 5. “Availability of substitutes of a good increases with the narrowness of its

definition.” Explain. In the light of your answer explain whether demand for ‘Surf excel’,
a brand of detergent powder, more or less elastic than the demand for all detergent
powders in general.
1. 6. What will be the shape of a unitary elastic demand curve and its corresponding
marginal revenue curve? Explain giving reasons.
1. 7. “Arc elasticity gives a better estimate of point elasticity of a curvilinear demand

curve as the size of the arc becomes smaller and the curvature of the demand curve
over the arc becomes less.” Explain.
1. 8. What is cross-elasticity of demand? How can we define an industry by using cross

elasticity?
1. 9. Neena consumes two goods X and Y with a fixed income; if her cross elasticity of
demand for X with respect to price of Y is greater than zero, then we can infer that her
demand for Y is less elastic. True or false, and why?
1. 10. If the inverse demand function is p = a – bq, where a and b are positive
constants,
what is the price elasticity at q = 0,at q =(a/b) and at q =(a/2b) ?
1. 11. The price elasticity of demand for a given commodity is alleged to be greater :
i. The more numerous and closer the substitutes.

ii. If it is a luxury rather than a necessity.
iii. If it accounts for a large proportion of the consumer’s income.
50
iv. At higher prices rather than lower prices. Explain the supporting argument in
each case and analyse its validity.
1. 12. How should a linear downward sloping demand curve shift if elasticity at each
price is to remain the same? Explain using diagram.
1. 13. A consumer spends all her income on two goods X and Y. If a 50% increase in the
price of good X does not change the amount consumed of Y, what is the price elasticity
of demand for good X?
1. 14. Suppose a consumer spends her entire income (I) on purchase of ‘n’ goods whose
quantities are denoted as q1 q2 ..., qn and price as p1, p2, ..., pn. Prove that if the own-
price elasticity of demand for a particular good exceeds one, then in some average
sense, the other goods are substitutes for the given good and if the own price elasticity
is less than one, then in that same sense, the other goods are complements of the given
good.
1. 15. Using calculus prove that the total amount spent on a good varies directly with
the change in price when elasticity is less than one, and inversely with the price when
elasticity is greater than one.
1. 16. Suppose that when Sachin’s income increases (prices of all goods unchanged), he
devotes the entire increment in income to increasing his purchase of food. Is Sachin’s
income elasticity of demand for food greater than, equal to, or less than one?
1. 17. What is the price elasticity of demand supposed to measure? State the point
elasticity and arc elasticity formulas for measuring elasticity of demand. When should
each be used?
1. 18. Compare the elasticity of two straight line intersecting demand curves at the print
of intersection.
1. 19. Prove that of two parallel straight line demand curves, the one farther to the right
has a smaller price elasticity at each price.
1. 20. Does a flatter demand curve necessarily signify a greater elasticity than a steeper
one?
1. 21. Prove that the proportion of income spent on a good rises with a rise in income if
the income elasticity of demand for the good is greater than one.
1. 22. Prove the followings geometrically:
a. When the supply curve of a good is an upward sloping straight line passing
through the origin, then all along the supply curve, elasticity of supply is equal to
one.
b. When the supply curve is an upward sloping straight line crossing price axis, then
elasticity of supply is greater than one at every print on the curve.
c. When the supply curve is a positively sloped straight line intersecting the
horizontal axis, then elasticity of supply is less than one at every point on the
supply curve.
51
Glossary
Complements - Two goods which are consumed together and for which the quantity
demanded of one is negatively related to the price of the other.
Cross elasticity of demand - The responsiveness of quantity demanded of a good to a

change in the price of another good.
Demand - The quantity of a good or service which an individual or group desires at the
ruling price.
Demand curve - A graphical presentation showing the relationship between the

quantity demanded of a good and its price.
Demand function - A functional relation between quantity demanded and all of the
variables that influence it.
Demand schedule - A numerical tabulation showing the quantities that are demanded
at various alternative prices.
Equilibrium - A position of rest. When applied to markets, equilibrium denotes a

situation in which, in the aggregate, buyers and sellers are satisfied with the current
combination of prices and quantity bought or sold, and so have no incentive to change
their current actions.
Income elasticity of demand - A measure of the relative responsiveness of the

demand of any good to a change in the level of income of the person demanding the
good.
Price elasticity of demand - The relative responsiveness of the quantity demanded of

a good to a change in its own price.
Price elasticity of supply - The responsiveness of the quantity supplied of a good to a

change in its own price.
Substitutes - Two goods are substitutes of each other if they satisfy essentially the
same want of the consumer such that the quantity demanded of one is positively related
to the price of the other.
Supply - The relation between the quantity of some commodity that producers are
willing to produce and sell per period of time and the price of that commodity, ceteris
paribus.
52
Supply curve - A graphical presentation of the relationship between the supply of a

commodity and its price.
Supply function - A mathematical relation between the quantity supplied and all the
variables that influence it.
Supply schedule - A numerical tabulation showing the quantity supplied at a number of

alternative prices.
53

Demand and Supply

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The Concept of Demand, Supply & Elasticity

Lesson: The Concept of Demand, Supply & Elasticity

Author: Nalini Panda, Associate Professor

Department/ College: Indraprastha College for Women, University of

1.1 demand and Supply

1.1.1 (a) An Individual’s Demand for a Product

Source: www.drawingcoach.com, www.photos.merinews.com

Qdx = f (Px, I, Po) (1.1)

f = a function of, or depends on, P x = the price of good X,

Eqn(1.3) is a ‘general’ functional relationship between quantity demanded of the good X

Figure 1.1: Linear Demand Curve

Qdx = a – b Px, (1.4)

The demand curve that will be derived will be non-linear as shown

Figure 1.2: Non Linear Demand Curve

Value Addition: Know more about non-linear demand functions

A non-linear demand function may take the following form.

Qdx = a(1/Pxb), (i)

Where, a and b are positive constants.

(dQdx/dPx) = -a.b(1/Pxb+1 ). (ii)

Qdx = 100/Px (iii)

1.1.1 (b) Movements Along vs. Shifts in Demand

Reinforce your learning

Reducing the Quantity of Tobacco Demanded

Reinforce your learning

Figure 1.3: Shift In Demand Curve

Figure 1.4: Shift In Demand Curve

Reinforce your learning

1.1.1 (c) Substitutability and Narrowness of Definition

1.1.1 (d) The Market Demand for a Product

Figure 1.5: Market Demand Curve

Figure 1.6: Derivation Of Markrt Demand Curve

i) Derive the individual demand schedules.

Price (in Rs.) 0 1 2 3 4 5 6 7 8 9 10

Individual Demand Schedule for B

Price (in Rs.) 0 1 2 3 4

1.1.2 (a) An Individual Firm’s Supply Curve

In simple mathematical language this functional relationship can be expressed as follows

or, Qsx = g (Px) cet. par. (1.7´)

Pi = the price of inputs,

Fn = features of nature such as climate and weather conditions.

For example, let a single firm’s supply function for good X be

Table 1.5 Individual Supply Schedule

Plotting each pair of values as a point on a graph and joining the

1.1.2 (b) Movements along, versus, Shifts in the Supply Curve

For example, if there is an improvement in technology, so that the cost of producing

Figure 1.8:Shift In Supply Curve

1.1.2 (c) The Market Supply of a Product

The market supply schedule will be given by Table 1.6.

Table 1.6 Market Supply Schedule

Figure 1.9:Derivation Of The Market Supply Curve

Figure 1.10: Equilibrium

1.2.1 Elasticity of Demand

1.2.1 (a) Own Price Elasticity of Demand

I. Definition and Measurement

If a given percentage change in the price of a good results in a greater percentage

and it gives us the formula to measure elasticity

II. Graphical Presentation of Elasticity

Figure 1.11: Demand Curve

Elasticity of demand at point E on the demand curve AJ will be given by . It can be

Elasticity of demand at point E is given by

To measure elasticity at a point on a non-linear demand curve we draw a tangent to the

In fig.1.12 the elasticity of the non-linear demand curve Dx at point E is given by

Figure 1.12: Non Linear Demand Curve

ηxx = -(dQx/dPx)(Px/Qx) = (ab/Pxb+1) (Px/a.Px-b) .

When Px=I, Qx=100 and ηxx= -(dQx/dPx)(Px/Qx) = (100/Px2)(1/100) =

TR = PxQx = 10Qx-(1/10)Qx2 (ii)