CHAPTER 3.B Flashcards
Definition of Demand by Prof. Alfred Marshall
According to Prof. Alfred Marshall, “ Elasticity of Demand is great or small according to the amount demanded which rises much or little for a given fall in price and quantity demanded falls much or little for a given rise in price. “
Meaning of Elasticity of Demand
- The term elasticity indicates responsiveness of one variable to a change in the other variable. Elasticity of demand refers to the degree of responsiveness of quantity demanded to a change in its price or any other factor.
- it is the ratio of percentage change in quantity demanded of a commodity to a percentage change in its price.
What is Income Elasticity?
It refers to the degree of responsiveness of a change in quantity demanded to a change in the income only, other factors including price remain unchanged. It is expressed as EY=Percentage change in Qty. Demanded/ Percentage change in Income.
What is Cross Elasticity of Demand?
It refers to a change in the quantity demanded of one commodity due to a change in the price of other commodity.(Complementary or substitute goods)
Ec= Percentage change in Qty. Demanded of A/ Percentage change in Price of B (Where A is the original commodity and B is the other commodity)
What is Price Elasticity of Demand?
According to Prof. Alfred Marshall, price elasticity of Demand is a ratio of proportionate change in the quantity demanded of a commodity to a given proportionate change in its price only. Ed= Percentage change in Quantity Demanded/ Percentage Change in Price
Price Elasticity Symboloically:
Symbolically, Ed = % △ Q / % △ P
Perfectly Elastic Demand (Ed = ∞)
When a slight or zero change in the price brings about an infinite change in the quantity demanded of that commodity, it is called perfectly elastic demand. This is a theoretical concept.
Example of Perfectly Elastic Demand:
A 10% fall in price may lead to an infinite rise in demand.
Graph of Perfectly Elastic Demand:
The demand curve (DD) is a horizontal line parallel to the X-axis, indicating perfectly elastic demand.
Perfectly Inelastic Demand (Ed = 0)
When percentage change in price has no effect on the quantity demanded of a commodity, it is called perfectly inelastic demand.
Example of Perfectly Inelastic Demand:
Eg. 20% fall in price will have no effect on quantity demanded.
Graph of Perfectly Inelastic Demand:
The demand curve is a vertical straight line parallel to the Y-axis, indicating that quantity demanded remains unchanged regardless of price changes.
Unitary Elastic Demand(Ed = 1)
When a percentage change in price leads to a proportionate change in quantity demanded then demand is said to be unitary elastic.
Example of Unitary Elastic Demand:
Eg. 20% fall in price = 20% rise in quantity demanded.
Graph of Unitary Elastic Demand:
The demand curve is a ‘rectangular hyperbola,’ indicating that when the price falls from OP to OP1 (50%), the demand rises from OQ to OQ1 (50%).
Relatively Elastic Demand (Ed>1)
When a percentage change in price leads to more than proportionate change in quantity demanded, the demand is said to be relatively elastic.
Example of Relatively Elastic Demand:
Eg. 50% fall in price leads to 100% rise in quantity demanded.
Graph of Relatively Elastic Demand:
The demand curve has a flatter slope, indicating that when the price falls from OP to OP1 (50%), the demand rises from OQ to OQ1 (100%).
Relatively inelastic demand (Ed<1)
When a percentage change in price leads to less than proportionate change in the quantity demanded, demand is said to be relatively inelastic.
Example of Relatively Inelastic Demand:
Eg. 50% fall in price leads to 25% rise in quantity demanded.
Graph of Relatively Inelastic Demand:
The demand curve has a steeper slope, indicating that when the price falls from OP to OP1 (50%), the demand rises from OQ to OQ1 (25%).
Factors influencing the price elasticity of demand.
Nature of commodity
Availability of substitutes
Number of uses
Habits
Durability
Complementary goods
Income of Consumer
Urgency of needs
Time Period
Proportion of expenditure
Importance of Elasticity of Demand:
Importance to a Producer
Importance to Government
Important in Factor Pricing
Importance in Foreign Trade
Public Utilities
Ratio or Percentage Method:
Developed by Prof. Marshall, this method measures elasticity of demand by dividing the percentage change in demand by the percentage change in price. Also known as the Arithmetic method.
Formula for Price Elasticity of Demand under the Ratio or Percentage Method:
Ed = Percentage change in Quantity demanded / Percentage change in Price
Ed = % △ Q / % △ P
Mathematically the above formula can be expressed as:
Ed = [△ Q / Q] / [△ P / P] , thus Ed = [△ Q / Q] / [P / △ P]
Total Expenditure Method:
Developed by Prof. Marshall, this method compares the total amount of expenditure before and after a price change. Total expenditure is calculated as the product of price and quantity demanded. It is also called Total Outlay method.
Formula for Total Outlay method:
Total expenditure = Price x Quantity Demanded
Relatively Elastic Demand in reference to Total Outlay Method:
When a given change in the price of a commodity leads to an increase in total expenditure, the elasticity of demand is greater than one. (Ed > 1)
Unitary Elastic Demand in reference to Total Outlay Method:
When a change in price does not affect the total expenditure, the elasticity of demand is equal to one. (Ed = 1)
Relatively Inelastic Demand in reference to Total Outlay Method:
When a given change in the price of a commodity leads to a decrease in total expenditure, the elasticity of demand is less than one. (Ed < 1)
Point or Geometric Method:
Developed by Prof. Marshall, this method measures elasticity of demand at a given point on the demand curve, unlike the ratio and total outlay methods.
Formula for Point Elasticity of Demand:
Point elasticity of demand (Ed) = Lower segment of demand curve below a given point (L) /
Upper segment of demand curve above a given point (U)
Point method on a Linear Demand curve:
When the demand curve is linear (a straight line), extend it to meet the Y-axis at ‘A’ and the X-axis at ‘B’. Elasticity varies at different points on the curve.
Point Elasticity at Various Points on a Linear Demand Curve:
At point P:
P = PB / PA = 4/4 = 1
Thus demand is Unitary Elastic (Ed = 1)
At point P1:
P1 = P1B / P1A = 2/6 = 0.33
Thus, demand is Relatively inelastic (Ed < 1)
At point P2:
P2 = P2B / P2A = 6/2 = 3
Thus, demand is Relatively elastic (Ed > 1)
At point A: (Y axis)
Ed = ∞
Perfectly elastic demand
At point B: (X axis)
Ed = 0
Perfectly inelastic demand
Non-linear Demand Curve:
For a non-linear (convex to origin) demand curve, draw a tangent ‘AB’ touching the given point on the curve and extend it to measure elasticity.
Point Elasticity at Various Points of a Tangent in a Non-linear demand curve:
If EB = EA (Ed = 1) - Unitary elastic demand
EB > EA (Ed >1) - Relatively elastic demand
EB < EA (Ed <1) - Relatively inelastic demand
