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ELASTICITY OF DEMAND
Elasticity of Demand
Measure of sensitiveness of demand. Responsiveness of demand to - Change in price (Ep) - Change in income (Ey) - Change in price of a related commodity (Ec) - Change in advertising expenditure (Ea )
Interpretation: A 10% reduction in price will result in a 2.5% increase in quantity demanded.
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Numerical Description Shape of expression curve 0 Infinite Zero One Horizontal Vertical Rectangula r hyperbola
Perfectly inelastic
Ep=0
Ep=1
Ep> 1
Ep<1
price
Quantity demanded
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Elasticity
Highly Elastic ( Ep >1)
Price
Increases
Quantity Demanded
Decreases
Total Outlay
Decreases
Decreases
Unitary Elastic ( Ep=1) Increases Decreases Highly Inelastic (Ep < 1) Increases
Increases
Decreases Increases Decreases
Increases
No Change No Change Increases
Decreases
Increases
Decreases
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C. 10 5
20
10 15
100
100 75
ep=1
ep<1
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Refers to USA Refers to urban India SR Ep : Short run Price elasticity LR Ep : Long run Price elasticity
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Ey = % change in Quantity demanded (Q) / % change in income of consumer (y) Q2-Q1/Q1 Y2-Y1/Y1 Positive Ey : When income increases, consumer buys more of the good e.g., Normal goods- clothes, food Zero Ey : No change in demand when there is a change in income- Neutral goods- salt, matchbox Negative Ey : When income increases, consumer buys less of the good Inferior goods
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Responsiveness of the demand of one good to the change in the price of a related good, ceteris paribus Ec = % change in Quantity demanded of X (Qdx) / % change in price of a related commodity, Y (Py) Related goods may be complementary (joint demand) or substitutes Positive Ec : Quantity demanded of X moves in the same direction as the price of Y Case of Substitutes E.g., Coke and Pepsi Negative Ec : Quantity demanded of X moves in the opposite direction as the price of Y Case of Complements Tea and sugar, car and 19
Consider 2 goods X and Y. There was no change in the price of Y but its demand fell from 6000 to 5500 units. On analysis it was found that the price of a related good X had risen to Rs. 250 from 225. Find the cross elasticity and the relationship between the two goods.
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Ec =
(Q2y-Q1y)/Q1y --------------(P2x-P1x)/P1x
(5500- 6000) / 6000
Cross elasticity = - 0.75 The negative cross elasticity indicates that X and Y are complementary goods.
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Cross Elasticity
Given cross elasticity, identify nature of relationship and give logical reasoning: Commodity Ec wrt P of: Ec 1. Dalda Butter 1.55 2. Natural gas Electricity 0.80 3. Clothing Food - 0 .18 4. Entertainment Food - 0.72
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Cross Elasticity
1.Dalda & Butter 1.55 Means 1% increase in price of butter leads to a 1.55% increase in demand for margarine. Thus, the two goods are substitutes. 4. Entertainment & Food -0.72 Means 1% increase in price of food leads to a decrease in demand for entertainment by 0.72%. Why?
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Firms use this concept to measure the effect of changing the price of a product they sell on the DD of other related products that the firm also sells. Changing the price of Maruti Suzukis Esteem and its effect on demand for Wagon R
Used for measuring interrelationships between sectorse.g. in an agrarian economy, knowledge of cross elasticity between demand for industrial products with respect to agricultural prices would indicate the extent to which farmers prosperity is the cause of industrial 24 growth.
Interpretation
Price elasticity of all three types of oranges was quite high (Bold face numbers- diagonal) Cross-price elasicities of demand between the two types of Florida oranges were higher than 1 (+1.16 and +1.56), indicating that they were close substitutes. Cross-price elasicities of demand between the two types of Florida and California oranges were close to zero (0.18,0 .09, 0.01, 0.14), indicating that California oranges were not viewed as substitutes to Florida oranges. So while pricing, the producers of Florida oranges should carefully consider the price of other Florida oranges, but need not be much concerned about price of California oranges.
Promotional Elasticity
Degree of responsiveness of demand to a change in advertising expenditure Higher the responsiveness, higher will be the firms incentive to advertise
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3.If advertising elasticity is highly inelastic, should the manager spend money on sales promotion or improving product quality?
Advertising wont increase revenue, so he should concentrate on product quality
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5.In a growing economy, if income elasticity for a firms product is very low, what should be the firms strategy?
May think of changing the product line to something more price elastic as the firm will no benefit from an increase in incomes.
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1.Items of joint consumption will have -------cross elasticity 2. When Ea is -------- than 1, the firm can incur heavy promotional expenditure. 3. When Ea is low, it means the firm should incur ________ expenditure on advertising its product. 4. A negative Ec between two goods implies that the two goods are ----------5. A higher positive Ec implies ________ substitutability between two items 6.Income elasticity of demand for diamonds would be: A) =1 B) =0 C) >1 D) <1 40
Knowledge Testing
1. Items of joint consumption will have negative cross elasticity 2. When Ea is greater than 1, the firm can incur heavy promotional expenditure. 3. When Ea is low, it means the firm should incur less expenditure on advertising its product. 4. A negative Ec between two goods implies that the two goods are complements. 5. A higher positive Ec implies greater substitutability between two items 6.Income elasticity of demand for diamonds would be: C) >1
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True of False
Alcohol is relatively price elastic. Governments impose higher taxes on goods with inelastic demand. The flatter the demand curve, the higher is the price elasticity. Distinguish between normal and inferior goods in terms of income elasticity of demand
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Sums in Elasticity
Compute the relevant elasticities of demand when the demand for a product increases from 100 to 150 units (when all other things remain constant) when i) Price of product decreases from Rs. 8 per unit to Rs. 6 per unit ii) Income of consumer increases from Rs. 1000 to Rs. 4500 iii) Price of a related good increases from Rs. 8 to Rs. 10 per unit. Also, state the relationship
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This meant a lot of research on price elastcity of demand for its products and how much cost increases could be passed on to consumers. The management also decided to strengthen the companys distribution since demand from rural India was growing strong. Castrols efforts to stay ahead of the technology curve by launching newer and better products consistently has also helped. It chose not to apply brakes on its advertising and brandbuilding exercises. To be contd for more 47 concepts
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Elasticity of supply
Ess = % change in quantity supplied / % change in price Flatter the supply curve , larger the elasticity
Summary
Responsiveness of quantity demanded to a change in Price, Income, price of related good or promotional expenditure. Price elasticity of demand measures % change in quantity demanded in response to a change in price. Degrees of price elasticity- diagrammatic representation Measuring Price elasticity Factors influencing Ep
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Summary
Income elasticity : Most goods are normal (Ei >0); for inferior goods Ei < 0; Normal goods with Ei >1 are called luxuries, while Normal goods with Ei between 0 and 1 are called necessities Cross elasticity: measures the response of demand of good X for a change in the price of a related good Y. Goods X and Y are substitutes if Ec is positive and complementary if Ec is negative Promotional Elasticity measures response of demand to a change in advertising expenditure Importance and use of the Concept in managerial decision making
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Retail sales of diesel have soared up to 20% in some regions in the past week as bulk buyers are making a beeline for cheaper fuel available at petrol pumps after the recent change in pricing norms. The surge has further distorted the retail market, which has already seen a massive shift of consumers to diesel cars as petrol prices are significantly higher. A sharp increase in CNG prices has added to the demand for diesel, which rose 22% in Delhi in the December quarter and continues to grow at the same scorching pace this month. Petrol sales in large cities such as Delhi have dropped 3% in recent months.
It is difficult to prevent malpractices. In the last few days, we have seen higher demand for diesel at retail outlets. In some markets, sales have risen 5%, in some cases 15%, and there are areas where sales have gone up even 20%," said a senior executive in IndianOil's marketing division. Sales have increased in Gujarat, where state roadways buses have started filling their tanks with diesel from petrol pumps. Other states also have similar plans, industry officials said. "In some places they have already shifted to petrol pumps and in other places they are making plans. The price differential is very high," an IOC executive said.
In Andhra Pradesh, retail sales at several pumps have risen 20% as industrial users are buying cheaper fuel at pumps, said Rajiv Amaram, joint secretary of the Confederation of Indian Petroleum Dealers, which represents 4,000 pumps in the state. "Fuel buyers, whether general or industrial users, normally go to bunks where they get relatively cheaper fuel. Anybody, whether retail or industrial user, is entitled to 2,000 litre of fuel purchase at retail pumps, and we cannot stop them from such purchases as long as they are under the prescribed limit per transaction," he told ET.
1. Identify the elasicity issues here 2. What are the micro-macro links implied?