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ELASTICITY OF DEMAND

- INTRODUCED BY ALFRED MARSHALL
- 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.

TYPES OF ELASTICITY OF DEMAND

- PRICE ELASTICITY OF DEMAND
- INCOME ELASTICITY OF DEMAND
- CROSS-ELASTICITY OF DEMAND

PRICE ELASTICITY OF DEMAND

- DEGREE OF RESPONSIVENESS OF QUANTITY DEMANDED TO A CHANGE IN PRICE IS CALLED PRICE ELASTICITY OF DEMAND.

PERCENTAGE CHANGE IN QUANTITY DEMANDED

PERCENTAGE CHANGE IN PRICE

=

SYMBOLICALLY

CHANGE

PRICE

QUANTITY

Q/Q

P/P

eP

P

Q

=

MEASUREMENT OF PRICE ELASTICITY OF DEMAND

- PERCENTAGE METHOD
- POINT METHOD OR SLOPE METHOD
- TOTAL OUTLAY METHOD
- ARC METHOD

PERCENTAGE METHOD

- RELATIVE CHANGE IN DEMAND DIVIDED BY RELATIVE CHANGE IN PRICE OR PERCENTAGE CHANGE IN DEMAND DIVIDED BY PERCENTAGE CHANGE IN PRICE.

%

%

Q

P

eP

=

FOR EXAMPLE IF PRICE OF RICE INCREASES BY 10% AND DEMAND FOR RICE FALLS BY 10%

eP

=

15/10

=

0.5

THIS MEANS THAT DEMAND FOR RICE IS INELASTIC

MEASURES OF ELASTICITY

- REALTIVELY ELASTIC IF e>1
- REALTIVELY INELASTIC IF e<1
- UNITARY ELASTIC DEMAND IF e=1
- PERFECTLY INELASTIC DEMAND IF e=0
- PERFECTLY ELASTIC DEMAND IF e=INFINITY

POINT METHOD

- WE CAN CALCULATE PRICE ELASTICITY OF DEMAND AT A POINT ON THE LINEAR DEMAND CURVE.

LOWER SEGMENT OF DEMAND CURVE

UPPER SEGMENT OF DEMAND CURVE

eP

=

For example in fig. the length of the demand curve AB is 4cm.

- Ep at point E ,ep = EB/EA = 2/2 = 1
- Ep at point D = (middle point of EB portion of demand curve) DB/DA = 1/3 = 0.3 ep<1
- Ep at point c(middle point of EA portion of demand curve) = CB/CA = 3/1 = 3 ep >1
- Ep at point B = 0/AB = 0/4 = 0
- Ep at point A = AB/0 = 4/0 = infinity

TOTAL OUTLAY METHODWe can measure elasticity through a change in expenditure on commodities due to a change in price

- Demand is elastic if total outlay or expenditure increases for a fall in price(ep>1)
- Demand is inelastic if total outlay or expenditure falls for a fall in price(ep<1)
- Demand is unitary if total expenditure does not change for fall in price(ep=1)

ARC METHOD

- SEGMENT OF DEMAND CURVE BETWEEN TWO POINTS IS CALLED AN ARC.

Q = change in qty demanded

P = change in price of the commodity

P1 = original price

P2 = New price

Q1 = original qty

Q2 = new qty

Ep = q1 – q2 / P1-P2

Q1+q2 P1+P2

= q

Q1+q2 /

P

P1+P2

INCOME ELASTICITY OF DEMAND

- DEGREE OF RESPONSIVENESS OF DEMAND TO CHANGE IN INCOME.

Ey = Percentage change in qty demanded

Percentage change in income

Q- quantity demanded

Y - income

Ey = q/q x y/ y

Cross elasticity of demand

- Responsiveness of demand to change in price of realted goods.

Ec = Percentage change in qty demanded of commodity X

Percentage change in price of commodity Y

Ec= qx/ py x py/qx

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