MEFA unit 2

1. Unit - 2
Elasticity of Demand
By
K.Arjun Goud
Assistant Professor
Department of MBA
Vidya Jyothi Institute of Technology

2. Elasticity
• Elasticity means Fluctuations due to other forces
• Before we understand Elasticity, we need to know
about Demand and law of demand

3. Demand
Demand means
•Desire to Purchase
•Willingness to buy
•Ability to purchase
•Capability to buy

4. Types of Demand
• Individual or Consumer
Demand
• Market Demand
• Derived Demand and Direct
Demand
• Industry Demand &
Company Demand
• Short-run Demand & Long
Run Demand
• Price Demand
• Income Demand
• Cross Demand

5. Law of Demand
• Definition of law of Demand states that " all other
factors remain constant, when price of the product
increases then demand of that product decrease,
when price of the product decreases then the
demand of that product increases."

6. Demand schedule
Combination Demand Price
A 10 10
B 20 8
C 30 6
D 40 4
E 50 2

7. Demand Graph

8. Determinants of Demand
• Price of the product
• Price of the alternative
product
• Income of the
consumer
• Taste and preference
• Population
• Consumer expectations

9. Exceptions of Law of Demand
• Giffen goods
• Veblen goods
• Future price changes
• Emergencies
• Population
• Consumer expectations
• Ignorance
• Taste and habits

10. Giffen goods
• A Giffen good, a concept commonly
used in economics, refers to a good
that people consume more of as the
price rises.
• Therefore, a Giffen good shows an
upward-sloping demand curve and
violates the fundamental law of
demand.
• It is important to note that all Giffen
goods are inferior goods, but not all
inferior goods are Giffen goods.

11. History of Giffen Good
• The term Giffen good was
named after Scottish
economist Sir Robert Giffen.
• The term Giffen good was
developed by the economist
after he noticed, in the poor
Victorian era, that the rise in
the price of a basic food
increased the demand for that
particular food.

12. Veblen Goods
• Very expensive products – such as designer jewelry,
pricey watches, and luxury cars – that are marketed
as being “exclusive,” or which convey the
appearance of success, can be classified as Veblen
goods

13. Future price changes
• The expectations that
sellers have concerning the
future price of a good,
which is assumed constant
when a supply curve is
constructed.
• If sellers expect a higher
price, then supply
decreases. If sellers expect
a lower price, then supply
increases.

14. Emergencies and Population

15. Taste,habits,Preference
• Consumer preferences are
defined as the subjective
(individual) tastes, as
measured by utility, of
various bundles of goods.
• They permit the consumer to
rank these bundles of goods
according to the levels of
utility they give the
consumer.
• Note that preferences are
independent of income and
prices.

16. Elasticity of Demand

17. Elasticity of Demand
• “Elasticity of demand is
the responsiveness of the
quantity demanded of a
commodity to changes in
one of the variables on
which demand depends.
• In other words, it is the
percentage change in
quantity demanded
divided by the percentage
in one of the variables on
which demand depends.”

18. Elasticity of Demand
formula
EoD = % Change in Quantity Demanded
% Change in Factors of Elasticity of Demand
Consider one of the factor as Price and the formula for EoD is
Mathematically, it can be expressed as :
Ed = ΔQ x P
Q Δ P
Where as
• ED = Elasticity of Demand
• ΔQ = Proportionate change in Quantity Demanded
• Q = Actual Demand
• ΔP = Proportionate change in the Price of the Product
• P = Actual Price of the product

19. Types of Elasticity of Demand
1. Price Elasticity of Demand
2. Income Elasticity of Demand
3. Cross Elasticity of Demand
4. Advertisement Elasticity of Demand

20. 1. Price Elasticity of demand
Price Elasticity of Demand states that,
Proportionate change in the Quantity
demanded is due to the Proportionate
change in the Price of the Product.
Formula
EDp = % Change in Quantity Demanded
% Change in Price of a Product

21. Price Elasticity of Demand (Contd.)
Mathematically, it can be expressed as :
Edp = ΔQ x P
Q Δ P
Where as
• Edp = Price Elasticity of Demand
• ΔQ = Proportionate change in Quantity Demanded
• Q = Actual Demand
• ΔP = Proportionate change in the Price of the Product
• P = Actual Price of the product

22. Types of Price Elasticity of Demand
• Perfectly Elastic Demand
• Perfectly Inelastic
Demand
• Unitary Elastic Demand
• Relatively Elastic Demand
• Relatively Inelastic
Demand

23. Types of Price Elasticity of Demand
2. Perfectly Inelastic Demand
Perfectly Inelastic Demand states that,
“Proportionate change in the Quantity
Demanded is zero even after
proportionate change in the price of
the product” (Ep = ∞)
Perfectly Elastic Demand curve
1. Perfectly Elastic Demand
Perfectly Elastic Demand states that,
“Proportionate change in the
Quantity Demanded is infinity i.e.
perfectly Elastic when price remain
constant” (Ep = ∞)
Perfectly Inelastic Demand curve

24. Types of Price Elasticity of Demand (contd..)
3. Unitary Elastic Demand
Unitary Elastic Demand States that, “Proportionate
change in the Quantity Demanded is equal to the
proportionate change in the price of the product”
(Ep = 1)

25. Types of Price Elasticity of Demand (contd..)
4. Relatively Elastic Demand
Relatively Elastic Demand
States that, “Proportionate
change in the Quantity
Demanded is more than the
proportionate change in the
price of the product” (Ep > 1)
5. Relatively Inelastic Demand
Relatively Inelastic Demand
States that, “Proportionate
change in the Quantity
Demanded is less than the
proportionate change in the
price of the product” (Ep < 1)
Relatively Elastic Demand Curve
Relatively Inelastic Demand Curve

26. 2. Income Elasticity of Demand
Income elasticity of demand states that,
“Proportionate change in Quantity demanded due
to the proportionate change in the income of the
consumer”
Formula
Edi = % Change in Quantity Demanded
% Change in Income of the consumer

27. Income Elasticity of Demand (Contd.)
Mathematically, it can be expressed as :
Edi = ΔQ x I
Q Δ I
Where as
• Edi = Income Elasticity of Demand
• ΔQ = Proportionate change in Quantity Demanded
• Q = Actual Demand
• ΔI = Proportionate change in the Income of the
consumer
• I = Actual Income of the consumer

28. 3. Cross Elasticity of Demand
Cross Elasticity of Demand states that, “Proportionate
change in quantity demanded of product X is due to the
proportionate change in the price of the product Y”
Formula
Edc = % Change in Quantity Demanded of Product X
% Change in Price of the alternative product Y

29. Cross Elasticity of Demand (Contd.)
Mathematically, it can be expressed as :
Edc = ΔQX x PY
QX Δ PY
Where as
• Edc = Cross Elasticity of Demand
• ΔQX = Proportionate change in Quantity Demanded of
product X
• QX = Actual Demand of Product X
• ΔPY = Proportionate change in the Price of the
alternative Product Y
• PY = Actual price of the alternative product Y

30. 4. Advertisement Elasticity of Demand
Advertisement elasticity of demand states that,
“Proportionate change in the quantity demanded is due to
the Proportionate change in the cost of the advertisement
of a product”
Formula
EdAD = % Change in Quantity Demanded
% Change in cost of the advertisement of a product

31. Advertisement Elasticity of Demand (Contd.)
Mathematically, it can be expressed as :
EdAD = Q2 - Q1 x Adc
Q1 ΔAdc
Where as
• Edc = Cross Elasticity of Demand
• Q2 - Q1 = Proportionate change in Quantity Demanded of
a product
• Q1 = Actual Demand of a Product
• ΔAdc = Proportionate change in the Cost of the
advertisement
• Adc = Actual cost of the Advertisement

32. Measurement of Elasticity of Demand
• Arc Method
• Point Method
• Proportionate or
Percentage method
• Total Outlay Method Measurement
of Elasticity of
Demand
Arc
Elastic
Method
Point
Method
Total
Outlay
Method
Proportionate
or Percentage
method

33. Arc Elastic Demand
Definition
• Arc elasticity of demand
measures elasticity between
two points on a curve – using
a mid-point between the two
curves.
• On most curves, the elasticity
of a curve varies depending
on where you are.
• Therefore elasticity needs to
measure a certain sector of
the curve.

34. Calculating Arc Elasticity of Demand
• To calculate arc elasticity of demand we first take
the midpoint in between.
• Once we have the midpoint, we calculate the PED
in the usual way
Arc Elastic Demand

35. Point Method
• Prof. Marshall devised a geometrical method
for measuring elasticity at a point on the
demand curve.
• Let RS be a straight line demand curve in
graph.
• If the price falls from PB(=OA) to MD(=OC).
the quantity demanded increases from OB to
OD.
• Elasticity at point P on the RS demand curve
according to the formula is:
• Where as ∆q represents changes in quantity
demanded, ∆p changes in price level, while p
and q are initial price and quantity levels.

36. Proportionate or Percentage method
• The price elasticity of demand is
measured by its coefficient (Ep).
• This coefficient (Ep) measures the
percentage change in the quantity of a
commodity demanded resulting from
a given percentage change in its price.
• Thus
• Where q refers to quantity demanded,
p to price and Δ to change. If EP>1,
demand is elastic. If EP< 1, demand is
inelastic, and Ep= 1, demand is
unitary elastic.

37. Total Outlay Method
• Marshall evolved the total outlay, or total revenue or
total expenditure method as a measure of elasticity.
• By comparing the total expenditure of a purchaser
both before and after the change in price, it can be
known whether his demand for a good is elastic,
unity or less elastic.
• Total outlay is price multiplied by the quantity of a
good purchased:
• Total Outlay = Price x Quantity Demanded.

38. Significance of Elasticity of Demand
• Price Discrimination
• Levy of Taxes
• International Trade
• Determination of Volume of Output
• Fixation of wages for labourers
• Poverty in the midst of plenty

39. Factors affecting the Elasticity of Demand
• Nature of the Product
• Availability of Substitutes
• Income level
• Level of Price
• Postponement of
consumption
• Number of uses
• Share in total expenditure
• Time period
• habits

40. Elasticity of Demand in Decision Making
• Price distribution
• Public Utility pricing
• Joint Supply
• Super Markets
• Use of Machine
• Factor Pricing
• International Trade
• Shifting of tax burden
• Taxation policy

41. Demand Forecasting
• Demand forecasting is a combination of
two words; the first one is Demand and
another forecasting.
• Demand means outside requirements of
a product or service.
• In general, forecasting means making an
estimation in the present for a future
occurring event.

42. Characteristics of good demand forecasting
• Accuracy
• Simple
• Economy
• Easy Availability
• Timeliness
• Capacity to update
forecast

43. Steps in Demand Forecasting

45. Supply
• Supply refers to the amount of a good or service
that the producers/providers are willing and able to
offer to the market at various prices during a period
of time.
• There are two important aspects of supply:
• Supply refers to what is offered for sale and not what is
finally sold.
• Supply is a flow. Hence, it is a certain quantity per day or
week or month, etc.

46. Determinants of Supply
• Price of a Good
• Price of a related Goods
• Price of Inputs
• State of the art technology
• Taxes and subsidies
• Nature of competition
• Firm’s Business objective

47. Supply Function
• It explains the relationship between the supply of a
commodity and the factors determining its supply.
• We can better represent the supply function in the form of
the following equation:
Sx = f (Px, PI, T, W, GP)
Where as,
• Sx = supply of commodity x
• Px = Price of commodity x
• PI = Price of inputs
• T = Technology
• W = Weather conditions
• GP = Government Policy

48. Law of Supply
• “Other things remaining unchanged, the supply of a
commodity rises i.e., expands with a rise in its price
and falls i.e., contracts with a fall in its price.
• In other-words, it can be said that - “Higher the
price higher the supply and lower the price lower
the supply.”
• The law thus suggests that the supply varies directly
with the change in price. So, a larger amount is
supplied at a higher price that at a lower price in the
market.

49. Explanation of the Law
This law can be explained with the help of a supply
schedule as well as by a supply curve based on an
imaginary figures and data.
Supply Schedule
Price of the Product (Rs) Supply of Product (Qty)
10 100
20 200
30 300
40 400
50 500

50. Supply Graph
Price
of
the
Product
Qty of Supply

51. Assumptions Underlying the Law of Supply
• No Change in the income
• No change in the technique of production
• There should be no change in transportation cost
• Cost of production be unchange’s
• There should be fixed scale of production
• There should not be any speculation
• The prices of other goods should remain constant
• There should not be any change in the government
policies