2. Meaning of Elasticity
• There is inverse relationship between demand
and price
– A change (rise or fall) in price leads generally to a
change in (contraction or extension) of demand
• This attribute of demand by virtue of which
stretches or contracts under the pressure of
price change is called Elasticity of demand
• Elasticity of demand is the measure of the
responsiveness of demand to changing prices
3. Elastic & Inelastic
Demand
• A change in demand is not always propionate to
change in price
– A small change in price may lead to a great change in
demand
– On the other hand, there is a possibility same change in
price may lead to a small change in demand
• In the case where change in small change in price lead
to great change then it is called elastic demand
– E.g. tv sets, DVD player
• Whereas, big change in price leading to small change
in demand is called inelastic demand
– E.g salt, bread
4. Different cases of Elasticity
• Perfectly Elastic or infinite elasticity
• Perfectly Inelastic or Zero elasticity
• Relatively elastic
• Relatively inelastic
• Unit elasticity
5. Infinite Elasticity
• Infinite elastic demand curve is parallel to x-axis
• It shows that even a small reduction in price may
lead to unlimited extension in demand
6. Zero Elasticity
• The demand curve is vertical straight line. It is parallel to Y-axis.
• It shows that how much price rise or fall demand of the commodity
remains the same
7. Relatively Elastic
• By relatively elastic demand we mean that with
increase or decrease in price quantity change is
relatively high
8. Relatively Inelastic
• By relatively inelastic demand we mean with decrease
or increase in price increase or decrease of demand is
relatively less
9. Unit Elasticity
• When there is similar increase quantity demanded due to change in
price then it is called unit elasticity
• The curve which we derive is called equilateral or rectangular
hyperbola
10. Relationship of Elasticity with Law of
DMU
• Marginal Utility varies with supply
– It falls when the supply is increased and rises
when the supply contracts
• Fall in MU does not occur at uniform rate in all
commodities
• For example in case of salt, we soon get fed up
and the MU falls very rapidly while in case of
luxuries MU comes down gradually
12. Price Elasticity
• Price elasticity measures responsiveness of
potential buyers to change in price
• It is the ratio of percentage change in quantity
demanded in response to a percentage
change in price
• Price Elasticity
PE= Proportionate change in amount demanded
Proportionate change in price
PE=∆q/q ÷ ∆p/p
13. Income Elasticity
• Income elasticity is a measure of
responsiveness of potential buyers to change
in income
• Income Elasticity
IE=Proportionate change in the quantity purchased
Proportionate change in income
IE= ∆q/q ÷ ∆y/y
14. Cross Elasticity
• Cross elasticity shows change in demand of
one product due to change in price of other
• Cross elasticity
CE= Proportionate change in purchase of commodity X
Proportionate change in price of commodity Y
CE= ∆qx/qx ÷ ∆py/py
15. Substitution Elasticity
• We make use of MRS discussed in IC Analysis
• The elasticity of substitutions shows to what extent one
commodity can be substituted for another without making
any change in the total level of satisfaction derived by the
consumer
• The elasticity of substitution of two goods is the measure of
the ease or difficulty with which one commodity can be
substituted for another
• There are two extremes:
– The elasticity of substitution may be infinite
• The goods which are perfect substitues
– The elatsticity of substitution may be zero
• Goods are not substitutes at all. They have to be used in fixed
proportion
• Between these two limits there can be various degrees of substitution
16. Substitution Elasticity
• When the substitution of one good for
another is difficult
– A small change in the ratio of the two goods will
bring about a great change in their marginal rate
of substitution
• When the substitution of one good for
another is easy
– A small change in their proportion with the
consumer will not make much change in their
MRS
17. Elasticity of substitution
• Elasticity of substitution
E= Δ(qx/qy) ÷ Δ(ΔY/ΔX)
qx/qy ΔY/ΔX
qx/qy= the original proportion between quantities of goods X and Y
Δ(qx/qy) = small change in the proportion of goods X and Y
ΔY/ΔX = MRS of X for Y
Δ(ΔY/ΔX)= the change in the MRS of X for Y
18. Relationship between
PE, IE and SE
• ep=K.Xei+(1-KX)es
– ep= price elasticity of demand
– ei= income elasticity of demand
– es= Substitution elasticity of demand
– KX is the proportion of the consumer’s income spent on commodity X
• In the above equation KXei shows the influence of
income effect on the price elasticity of demand
• (1-KX)es shows the substitution effect. A fall in price
of X will lead to its substitution for other goods
19. Factors Determining
Price Elasticity of Demand
• Necessaries
– Elasticity of price of necessaries e.g. salt, wheat, may
be inelastic
• Luxuries
– Demand for luxuries e.g. refrigerator, TV, car, is elastic
• Proportion of Total Expenditure
– If a consumption of good absorbs only a small
proportion of total expenditure e.g. salt etc. the
demand will not be much affected by price
• Substitutes
– Elasticity also depends on availability of substitutes
e.g tea and coffee
• Goods having several Uses
– Demand of good having several uses is elastic e.g. coal
20. Factors Determining
Price Elasticity of Demand
• Joint Demand
– E.g. carriages become cheap but price of horses continues
to rule high demand of carriages will not go up.
• Goods the use of which can be postponed
– E.g. building a house, a furniture etc. can be postponed
due to wait till fall in its prices
• Level of prices
– If some thing is very expensive its little decrease in price
will not do much. Similarly if some thing is too cheap its
demand will also not increase much as people would have
bought
• Market Imperfections
– The consumer may not be aware of the change in prices in
the market
• Technological factors
– E.g Tonga and car
22. Total Outlay Method
• According to this method, we compare the total outlay
of the purchaser (or total revenue i.e. total value of
sales from the seller’s point of view) before and after
the variations in price
• Elasticity of demand is expressed in three ways
– Unity
• It is unity, when, the price has changed, the total amount spent
remains the same
• The rise in price is exactly balanced by reduction in purchases and
vice versa
– Greater than unity
• Elasticity is greater than unity, (the demand is elastic) between
two prices
• When the price falls, total amount spent increases and vice versa
– Less than unity
• Elasticity is less than unity, (the demand is inelastic), if with a rise
in price total amount spent increases and with decrease in price
total amount spent decreases
23. Example
Price of Pencil Per Quantity Total Outlay
Dozen (Rs.) Demanded (Revenue)
1 8 3 24
2 7 4 28
3 6 5 30
4 5 6 30
5 4 7 28
6 3 8 24
Between S No. 1 and 2, and 2 and 3 price elasticity is greater than unity
Between S No. 3 and 4, price elasticity is unity
Between S No. 4 and 5, and 5 and 6 price elasticity is less than unity
24. Proportional Method
• In this method, we compare the percentage
change in price with the percentage change in
demand
• Price elasticity
= Proportionate change in amount demanded
Proportionate change in Price
= change in demand + change in price
amount demanded Price
25. Geometrical Method: Point Elasticity
• This method tells us how to measure elasticity
of demand at any point on demand curve
26. Arc Elasticity
• We express the price change as a proportion of the average of the
initial price and change in price
• Arc Elasticity
=Δq/Δp X p/q
27. Practical Applications
• Taxation
– More revenue if tax is collected from the goods which demand is
inelastic
• Monopoly Price
– More price incase of inelastic demand
• Output
– Demand of consumer and market e.g. newspaper
• Wages
– If DD of any particular labour is inelastic, it is easy to raise wages
• Effect on the economy
– The working of economy is affected by the nature of consumer
demand
– Producer’s demand for different factors of production also affect the
economy
• Economic Policies
– In regulation of economy it helps
• International Trade
– The nature of demand for the internationally traded goods is helpful in
determining the quantum of gain accruing to the respective countries
