The Concept of Elasticity of Demand

Presented By:

Dr. Kavita SrivastavaAssistant Professor

Department of Management

ITS,Ghaziabad

Definition of Elasticity of Demand

• “Elasticity of demand is defined as the degree of responsiveness of demand of a commodity to the change in its determinants”

The Concept of Elasticity of demand plays a crucial role in Business Decision making:

• Elasticity of demand helps the firms in fixing high prices if the cost of production increases and hence earn higher profits.

• When cost of production increases the firm will like to pass it to the consumers in the form of increased price of the commodity.

• Whether raising the price will be beneficial or not will depend upon:

The price elasticity of demand for the product. The price elasticity of demand of its substitutes.

Increasing price will be beneficial only if:

• Demand for the product is less elastic.• Demand for its substitutes is less elastic.

Although most businessmen are intuitively aware of the elasticity of demand of the goods they produce, the use of elasticity of demand adds precision to their business decisions.

The concepts of elasticity of demand used in

business decision making

• Price elasticity of demand• Cross elasticity of demand• Income elasticity of demand

Price elasticity of demand

• Price elasticity of demand is defined as;

“the degree of responsiveness of demand to the change in its price”.

or,

ep = % change in quantity demanded

% change in price

ep= ΔQ × P

ΔP Q

Measurement of elasticity of demand

• Graphical Method

• Point Method

• Expenditure Method

Graphical Method

• Perfectly Elastic Demand (ep= infinity)

P D

O X

Y

Q Q1

Quantity Demanded

price

• Perfectly inelastic demand (ep = 0)

Y

XOQ

D

P

P1

Quantity Demanded

price

Less Elastic Demand (ep<1)

Y

XO

D

D

P1

P

Q1 QQuantity Demanded

price

• Relative Elastic Demand

O X

Y

D

D

P

P1

Q1 Q

Quantity Demanded

price

• Highly Elastic Demand (ep>1)

Y

XO

D

DP

P1

Q1 Q

Quantity Demanded

price

Point Elasticity of Demand

ep=1

ep=0

ep<1

ep=infinity

ep>1Formula :ep=lower segment upper segment

Expenditure Method

• Elastic Demand ( ep>1)

P

(Rs.)

Q

(Nos.)

TE

(Rs.)

6 10 60

5 13 65

P

(Rs.)

Q

(Nos.)

TE

(Rs.)

6 10 60

5 11 55

Inelastic Demand (ep<1)

• Unitary Elastic Demand (ep=1)

P

(Rs.)

Q

(Nos.)

TE

(Rs.)

6 10 60

5 12 60

Income elasticity of Demand

• Income elasticity of demand is defined as the degree of responsiveness of demand of a commodity towards the change in income of the individual.

• Formula :

ey= ΔQ × Y

ΔY Q

Cross Elasticity of Demand

• “The cross elasticity of demand is defined as degree of responsiveness of demand of Commodity X to the change in price of the Commodity Y”.

• Formula :

ep= ΔQx × Py

ΔPy Q

Determinants of price elasticity of demand

• Availability of substitutes

• Nature of commodity

• Proportion of income spent

• Number of uses of commodity

• Postponement of consumption