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Elasticity . . .
is a measure of how much buyers and sellers respond to changes in market conditions
elasticity of demand is the percentage change in quantity demanded given a percent change in the price.
is a measure of how much the quantity demanded of a good responds to a change in the price of that good.
It
Determinants of Elasticity
Time period the longer the time under consideration the more elastic a good is likely to be Number and closeness of substitutes the greater the number of substitutes, the more elastic The proportion of income taken up by the product the smaller the proportion the more inelastic Luxury or Necessity - for example, salt & luxury cars
Example: If the price of an ice cream cone increases from 2.00 to 2.20 and the amount you buy falls from 10 to 8 cones then your elasticity of demand would be calculated as:
Ranges of Elasticity
Perfectly
Inelastic
Inelastic Demand
Quantity demanded does not respond strongly to price changes. Price elasticity of demand is less than one.
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Ranges of Elasticity
Unit
Elastic
Elastic
Demand
5 1. An increase in price... 4
Inelastic Demand
- Elasticity is less than 1
Price 5
Elastic Demand
- Elasticity is greater than 1
Price
Demand
Quantity
This method, measures the change on expenditure on commodities due to a change in price. If a given change does not cause any change in the total amount spent on the commodity, the demand is said to be unitary elastic. If the total expenditure increases due to fall in price, the demand is said to be elastic and vice versa.
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4.00 3.00
4.5 6
18 18
As price falls, the quantity demanded increases, But the total outlay remains constant. Hence, elasticity of demand is equal to unity.
Demand is Elastic
Price ( in Rs.) 4.50 Quantity demanded 6 Total expenditure 27
4 3
7 10
28 30
As price falls, the quantity demanded increases, And the total outlay also increases. Hence, demand is elastic. ( Greater than unity)
Demand is inelastic
Price ( in Rs.) 4.50 Quantity demanded 4 Total expenditure 18
4 3
4.25 5
17 15
As price falls, the quantity demanded increases, but the total outlay decreases. Hence, demand is inelastic. ( Lesser than unity)
Midpoint Formula
The midpoint formula is preferable when calculating the price elasticity of demand because it gives the same answer regardless of the direction of the change.
(Q2 Q1 )/[(Q 2 Q1 )/2] Price Elasticity of Demand = (P2 P1 )/[(P2 P1 )/2]
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(10 8) 22 percent (10 8) / 2 2.32 ( 2.20 2.00) 9.5 percent ( 2.20 2.00) / 2
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Geometric method
Elasticity at a point on a straight line demand curve can be calculated as follows : e= Length of the lower segment -------------------------------------------------Length of the upper segment
At the midpoint of the demand curve e = 1 At all points above the midpoint e >1 At all points below the midpoint e < 1
Geometric Method
At the point M, the demand curve is unit elastic. M is the midpoint of this linear demand curve Above M, demand is elastic, Below M, demand is inelastic
Price
Elasticity < 1
Quantity
Supply
5 1. An increase in price... 4
Inelastic Supply
- Elasticity is less than 1
Price 5
Quantity
Elastic Demand
- Elasticity is greater than 1
Price
5 4
50
Supply
2. At exactly 4, Producers will sell any quantity. Quantity
Normal Good demand rises as income rises and vice versa Inferior Good demand falls as income rises and vice versa
Elasticity
Price
The importance of elasticity is the information it provides on the effect on total revenue of changes in price.
Total Revenue
Elasticity
Price
If the firm decides to decrease price to (say) 3, the degree of price elasticity of the demand curve would determine the extent of the increase in demand and the change therefore in total revenue.
Total Revenue
D
100 140 Quantity Demanded
Elasticity
Price 10
% Price = -50% % Quantity Demanded = +20% Ped = -0.4 (Inelastic) Total Revenue would fall
Elasticity
Price ()
Producer decides to reduce price to increase sales % in Price = - 30% % in Demand = + 300% Ped = - 10 (Elastic) Total Revenue rises Good Move!
D
10 7
Quantity Demanded
20
Elasticity
If demand is price elastic: Increasing price would reduce TR (% Qd > % P) Reducing price would increase TR (% Qd > % P)
If demand is price inelastic: Increasing price would increase TR (% Qd < % P) Reducing price would reduce TR (% Qd < % P)
Importance of Elasticity
Relationship between changes in price and total revenue Importance in determining what goods to tax (tax revenue) Importance in analysing time lags in production Influences the behaviour of a firm
For a Businessman : If a businessman finds that the demand is inelastic, he is free to increase prices. In case if the demand is elastic, by slightly reducing the price, the demand will increase sharply and hence the total revenue will also increase. The better a company can assess future demand, the better it can plan its resources. Each company is exposed to three types of factors influencing demand: company, competitive and macroeconomic factors.
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Demand Forecasting
A forecast is a prediction or anticipation of any event which is likely to happen in future. Demand forecast is the prediction of the future demand for a firms product. It can either be made through experience or by statistical methods.
5. It is the overall base that determines the companys business and marketing plans, which are further broken down into specific goals marketing offer.
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Users Expectations
Consumer and industrial companies often poll their actual or potential customers. Some Industrial manufacturers ask about the quantities of products their customers may purchase in future and take this as their forecast.
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Delphi Method
Administering a series of questionnaires to panels of experts. This method gathers information from all experts and the opinion of all the experts is shared by all other experts. In case if an expert finds that his own forecast is unrealistic, after going through the opinion of other experts, there is a chance for corrections.
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Projection Approach
In this method, the past experience is projected for the future. This can be done by tow methods : Correlation or regression analysis. Time series analysis.
Nave Method
Next Years Sales = This Years Sales X This Years Sales Last Years Sales
Moving Average
Moving averages are used to allow for marketplace factors changing at different rates and at different times.
PERIOD 1 2 3 4 5 6
Forecast Sales
Sales
1986
1987 Time
1988
1989
1990