Unit 3 ME

Elasticity of Demand

elasticity of demand

Responsiveness of the demand for a good or service
to the increase or decrease in its price. Normally,
sales increase with drop in prices and decrease with
rise in prices. As a general rule, appliances, cars,
confectionary and other non-essentials show
elasticity of demand whereas most necessities (food,
medicine, basic clothing) show inelasticity of demand
(do not sell significantly more or less with changes in
price).
Price Elastic Demand
Definition: Demand is elastic if a change in
price leads to a bigger % change in demand;
therefore the PED will therefore be greater
than 1.
Goods which are elastic, tend to have some or all of the following characteristics.
1. They are luxury goods

2. They are expensive and a big % of income e.g. sports cars and holidays
3. Goods with many substitutes and a very competitive market. E.g. if
Simsbury’s put up the price of its bread there are many alternatives, so
people would be price sensitive
4. Bought frequently
PED = % change in Q.D.
% change in price

TYPES OF PRICE ELASTICITY
1. PERFECTLY ELASTIC DEMAND.

2. PERFECTLY INELASTIC DEMAND.
3. RELATIVE ELASTIC DEMAND.
4. RELATIVE INELASTIC DEMAND.
5. UNITARY ELASTIC DEMAND.
Perfectly Elastic Demand
• A good with a perfectly flat
demand curve has a price
elasticity of demand of
infinity. This would mean
that a small change in price
would lead to an infinitely
large increase in Demand.
• In perfectly competitive
markets (such as, say, coal),
if you can charge slightly less
than your competitors, and
still make a profit, you will
find your customers will
attempt to buy as much as
you can produce.
Perfectly Inelastic Demand
• To have a situation
where the Demand
curve is a vertical line is
to think of a good
where a certain
quantity is demanded,
regardless of the price.
• Heroin would be the
closest ''real life''
example of such a good.
Addicts will pay
anything for their ''fix''.
RELATIVE ELASTIC DEMAND
If proportionate change
in quantity demanded
is great than the
proportionate change is
price then, relatively
E>1 elastic is greater than 1.
We can indicate it as
EP>1. We can say a
small change in price
leads to a big change in
quantity demanded. In
the case of increase or
decrease we can say
demand is relatively
elastic.
RELATIVE INELASTIC DEMAND
If there is less than
proportionate
change in demand
E<1. to the change in
price, there is a
relatively inelastic
of demand. It can
be denoted as E<1
Unit Elasticity – The
theory takes place
E=1 when change in
demand is
proportionate to the
change in price. The
unit can be denoted
as E=1
cross-price elasticity of demand

Proportionate change in the demand for one item in response
to a change in the price of another item. It is 'positive' where
the two items are mutual substitutes, and any increase in the
price of one (say butter) will increase the demand for the
other (say margarine). It is 'negative' when the items are
complementary and any increase in the price of one (say cars)
will decrease the demand for the other (say tires). Also called
as Cross-elasticity of demand
.
Will total
Value of the Price rise
What will happen to the quantity demanded? revenue rise or
elasticity or cut?
fall?
Ed = 0 The demand curve is vertical, so demand remains the same but

Price rise Rise
with a higher price.
(Perfectly The demand curve is vertical, so demand remains the same but
Price cut Fall
inelastic) with a lower price.
0 < Ed 1 The demand curve is relatively steep, so the fall in demand will be
Price rise Rise
proportionately smaller than the rise in price.
(Relatively The demand curve is relatively steep, so the rise in demand will be
Price cut Fall
inelastic) proportionately smaller than the cut in price.
Measurements of Price Elasticity of Demand
1. Ratio Method :- = ∆Q/Q X P/∆P
2. Total Outlay Method.= P*Q

3. Point Elasticity Method.
(The Geometric Method)
Factors Influencing Elasticity of Demand
1. Nature Of Commodity.
2. Availability of Substitutes.
3. Number Of Uses.
4. Consumer’s Income.
5. Height and Range of Price Change.
6. Proportion of Expenditure.
Cont………
7. Durability of the Commodity.

8. Habit and Custom.
9. Complementary Goods.
10. Time.
11. Recurrence Of Demand.
12. Possibility of Postponement.
• Income elasticity of demand.
• Cross Elasticity of Demand.
• Arc Elasticity of Demand.
• Promotional or Advertisement Elasticity of
Demand.
• Arc Advertisement Elasticity.
PRACTICAL APPLICATION
1. TO BUSINESSMEN.
2. TO Govt. & FINANCE MINISTER.
3. IN INTERNATIONAL TRADE.
4. TO POLICY MAKERS.
5. TO TRADE UNIONS.
6. OTHERS ???
USEFULNESS IN THE FOREIGN TRADE
• PRICE ELASTICITY.
• INCOME ELASTICITY.
• CROSS ELASTICITY.
• PROMOTIONAL ELASTICITY.
Value of Price rise or What will happen to the quantity demanded? Will total
the cut? revenue
elasticity rise or fall?
Ed = 0 Price rise The demand curve is vertical, so demand remains the same Rise
but with a higher price.
(Perfectly Price cut The demand curve is vertical, so demand remains the same Fall
inelastic) but with a lower price.
0 < Ed 1 Price rise The demand curve is relatively steep, so the fall in demand Rise
will be proportionately smaller than the rise in price.
(Relatively Price cut The demand curve is relatively steep, so the rise in demand Fall
inelastic) will be proportionately smaller than the cut in price.
Ed = Price rise or a The demand curve is a parabola, so the change in price (up Unchanged
1(Unitary price cut or down) will be proportionately the same as the change in Revenue
elasticity) demand.
1 < Ed < ∞ Price rise The demand curve is relatively flat, so the fall in demand Fall
will be proportionately larger than the rise in price.
(Relatively Price cut The demand curve is relatively flat, so the rise in demand Rise
elastic) will be proportionately larger than the cut in price.
THANKS……………

Unit 3 ME

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Elasticity of Demand

1. They are luxury goods

PED = % change in Q.D.

% change in price

1. PERFECTLY ELASTIC DEMAND.

Ed = 0 The demand curve is vertical, so demand remains the same but

1. Ratio Method :- = ∆Q/Q X P/∆P

2. Total Outlay Method.= P*Q

7. Durability of the Commodity.

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