elasticity pp t

7/27/2019 Elasticity Pp t

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Elasticity ofDemand


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Introduction

There is relationship between demand and price Law of Demand

It indicates the direction of change of quantitydemanded to change in price.

But it does not give the answer to how much or towhat extent?

This information is given by Elasticity of Demand.


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Elasticity of Demand

It is defined as degree of responsiveness of quantitydemanded of a good to changes in one of thevariables .

Price Consumers Income Prices of related goods


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Price Elasticity of Demand

It is defined as ratio of the percentage change in quantitydemanded of a commodity to percentage change in price.

ep = % change in QD% change in Price

The price elasticity are expressed with a +ve sign even if

they are inversely related as we want to measure themagnitude of responsiveness .


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Price Elasticity of Demand


ep = Change in Quantity * 100Original Quantity

Change in Price * 100Original Price

ep = q * p q p

It has a negative sign The price elasticity are expressed with a positive sign even if

they are inversely related as we want to measure themagnitude of responsiveness .


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Numerical

Q 1. The price of a Chocolate Bar in the local newsagent risesfrom 25p to 30p. As a result, the newsagent finds that the

demand for this product falls from 80 bars a day to 40 barsa day. Find the price elasticity of demand.(-2.5)

Q2. The price of a litre of unleaded petrol rises from Rs 80 toRs 84 . As a result, the quantity demanded at a localstation falls from 4000 to 3880 litres a day. What is theprice elasticity of demand?

(-0.6)

Notice:The answer is negative. This is because the price rose (+ve) causing the quantity demanded to fall (-ve).The demand curve is nearly always downward slopingshowing a negative relationship between price and quantitydemanded


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Q A company decides to increase the price of Brand X drink from Rs2 a bottle to Rs2.10 abottle. The price elasticity of demand for BrandX is 0.8. He currently sells 300 bottles a day.

What will the new demand be (ceteris paribus)?

Ans 288


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Three Concept ofDemand Elasticity

1. Price Elasticity: Degree of responsiveness to change in its price

2. Income Elasticity: Sensitiveness of quantity demanded to change in income.

3. Cross Elasticity: Degree of responsiveness to change in the price of arelated good (Substitute /Complement).


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Types of Price Elasticity

The value of ep varies from Zero (0) to Infinity ( )

Elastic Demand:

When the percentage

change in quantitydemanded is greater thanpercentage change in price.

Inelastic Demand:

When the percentage

change in quantitydemanded is less thanpercentage change in price.

O M M

P

P

D

D

O M M

P

P

D

D


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There are 5 types of price elasticity

The main reason for differences in elasticity is thepossibility of s u b s t i t u t i o n i.epresence or absence of competing products.

1) Perfectly Elastic or ep = When demand is infinite or unlimited at given price. A reduction in price causes thequantity to increase fromzero to infinite.


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2) Perfectly Inelastic or ep = 0 When change in prices havea zero impact on thequantity demanded

3) Unitary Elastic Demand or ep = 1When change in quantitydemanded is equal tothe change in price .


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4) Relatively Elastic or ep > 1 When change in quantitydemanded is greater than change in prices

5) Relatively Inelastic or ep < 1When change in quantity

demanded is lessthan the change in price.


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To Summarise


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Determinants of PriceElasticity

The Availability of Substitutes The number and kind of substitute makes the consumer

sensitive to change in prices. If close substitute are available, its demand is elastic.

If no close substitute are not available, even with rise inprice the demand is inelastic.

The proportion of Consumer Income spent Greater the proportion of income spent o the commodity,

greater the elasticity of demand.

The number of uses of a commodity The greater the number of uses to which a commodity

can be put, the greater will be its price elasticity of demand.


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Determinants of PriceElasticity

Complementarity between Goods Complementarily or joint demand for goods effects

the elasticity Consumers are less sensitive to change in prices of

goods that are complementary with each other.

Time and Elasticity Demand is more elastic if the time involved is long, as

consumers can substitute goods in the long run. Demand is inelastic in the short run.

Durability of the commodity


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Measurement ofPrice Elasticity


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Methods

Percentage Method

Midpoint Method

Total Outlay Method


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1) Percentage Method:

It is defined as ratio of the percentage change in quantity

demanded of a commodity to percentage change in price.


ep = Change in Quantity * 100Original Quantity

Change in Price * 100Original Price

ep = q * p p q


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Numerical

Q. If the price of the commodity falls from Rs 6 toRs 4 per unit and due to it QD increases from80 units to 120 units.Find out the price elasticity of demand?

Ans: 1.5

Q. If the price of the commodity rises from Rs 4 toRs 6 per unit , the QD falls from 120 to 80 units.What is the price elasticity of demand?

Ans: 0.60


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3) Total Revenue Method

Total revenue is the amount received by theseller from the sale of the quantity of thegood sold in the market.

Total Revenue: P * Q


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Numerical

Q. Suppose a seller of a textile cloth wants to lower the priceof its cloth from Rs 150 per metre to Rs 142.5 per metre.If its present sales are 2000 metres per month and further estimated that its elasticity of demand for the productequals -0.7. show

a) Whether or not total revenue will increase as a resultof his decision to lower the price.

Ans: 2070

b) Calculate the exact magnitude of its new total revenue. Ans: Rs 2,94,975(With reduction in price his total revenue has decreased)


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1. Demand is elastic ( ep >1)The % increase in quantity demanded of the commoditywill be greater than the % fall in price.Total Revenue will increase.Conversely a rise in price reduces Total revenue.

P

P

Q Q

RR

For Example: A vegetable seller decides to cut the price of his potatoesfrom Rs 40/Kg to Rs 32p/Kg. The ep for this product is 2.He currently sells 80 Kg of potatoes a day. How many will he

sell after the price cut?

But what will happen to his revenue?


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But what will happen to his revenue?

Revenue before the price cut: Rs 40 80Kg = Rs3200Revenue after the price cut: Rs32 112Kg = Rs3584

The price cut causes revenue to increase.The rise in demand as a result of the price cut wasproportionately higher than the fall in price

'gain ' box is larger than the ' loss ' box,

so the seller's total revenue has increased


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b) What will happen if he increase the price to Rs 44 / kg

Revenue before the price increase: = 40p 80 = Rs3200Revenue after the price increase: = 44 64 = Rs 2816


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2. Demand is Inelastic (ep


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a) What happens when the price is cut to Rs 72 per litre. The

cut in the price will lead to an increase in less demand. Thenew demand will be 4200 litres.

Revenue before the price cut: = 80 4000 litres = 3200Revenue after the price cut: = 72 4200 litres = 3024

There is a fall in total revenue where the ' loss ' box is muchbigger than the ' gain ' box.


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3. Demand is Unit elastic ( ep = 1)The percentage increase in quantity demanded of thecommodity will be equal to the percentage fall in price.Total Revenue will be same.

Q

P

P

Q

R

R


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Elasticity and Revenue

P Qd TRP *Q

(ep)

5.00 30 150 -

4.75 40 190 e >14.50 50 225 e >1

4.25 60 255 e >1

4.00 75 300 e >1

3.75 80 300 e =1

3.50 84 294 e


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To Summarise..


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Numerical

Q1. Price of the good falls from Rs 10 to Rs 8 per unit. As aresult, its quantity demanded increases from Rs 80 unitsto 100 units. Find out the elasticity of the goods.

Ans: ep=1

Q2. If the price of commodity rises from Rs 15 to Rs 16 per unit. As a result the QD falls from Rs 100 to 80 units.Find out ep is more than one or less than one?

Ans: ep> 1

Q3. The ep for petrol is equal to unity and at Rs 15/litre anindividual demand 80 litre of petrol in a week. How muchprice of petrol should be fixed so that he demands 60 litresof petrol?

Ans: 60 Litre


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Importance for BusinessDecision Making

Pricing of Public Utilities:Charging higher prices for high end consumers/ lower pricesto the low end consumers.

International Trade:Charge a higher export prices if the demand for exports isinelastic, charge lower prices and earn higher revenue.

Product differentiation and Differential pricing:

Company to produce different products and charge differentprices depending on the elastic or inelastic demand.

Shifting the Taxation:

Shifting the taxation depends upon the elasticity of demand.


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Cross Elasticity of Demand

The degree of responsiveness of demand for one good inresponse to the change in prices of another good.

Good X and Good Y are substitute of each other

P1

P2

Q1 Q2Good Y

P

M1

M2Good X

What would have happen if Good X & Y werecomplement Goods?


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Cross Elasticity of Demand

ec = Percentage change in Qd of XPercentage change in the price of good Y

ec = Qx2 Qx1 Py2 Py1Qx2 + Qx1 Py2 + Py1

2 2


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Substitute and ComplementaryGoods

Positive Cross Elasticity: Rise in price of good X leads to rise in demand of

good Y They are substitute goods

Negative Cross Elasticity: Rise in price of good X leads to fall in demand of good Y They are Complementary goods

Zero Cross Elasticity: Rise in price of good X will have no effect on good Y They are unrelated goods


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Importance for Business DecisionMaking

It helps in formulating pricing strategy for multi-productfirms.

It defines the boundaries of an Industry( Anyone company cannot raise the price of the productwithout losing sales to the other firm)


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Numerical

Q.Colgate sells its standard size toothpaste for Rs 25. Its saleshave been on an average 8000 units per month over thepast year. Recently, its close competitor Binaca reduced theprice of its same standard size toothpaste from Rs 35 toRs30. As a result colgate sales declined by 1500 per unitsper month.

1) Calculate the cross elasticity between the two products.

2) What does it indicate about the relationship between thetwo.


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Importance for Business Firms

The firms which are producing goods which have highincome elasticity have a great potential for growth. The firms will be located in those areas which are

growing The marketing strategies will be targeted to those

segment whose income is increasing.

Demand for products which have low income elasticity

will be not be greatly effected by economic fluctuations.( Recession proof)

elasticity pp t

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