Question no.1

WHAT ARE THE VITAL FUNCTIONS OF ECONOMY ? EXPLAIN THE PRICE MECHANISUM?

Answer:

THE VITAL FUNCTIONS OF AN ECONOMY:

Feeding, digestion and growth are known as the vital processes of human existence. In the same way every economy has its vital processes, which are production, consumption and growth. All economies preform these three basic functions though they differ with regard to the volume of production and consumption and the rate of growth.

PRODUCTION OF GOODS AND SERVICES:

The first vital function of an economy is production, which takes place continuously. Different varieties of food and clothing, of entertainment and amusement, radios, cinemas, etc., are produced by the economy. Production consist of final; consumption goods, services of all types, products in different stages of production, and so on. According to economists, production is not complete unless the product is taken to the hands of consumer, and accordingly, production embraces trade too. The process of production continues till the product reaches the hands of the consumers.

The term ‘production’ is a broad one and it includes various kinds of production. Production may take the form of transformation of one product into another, that is, from a commodity with lower utility to another commodity, which has higher utility. e.g. Production of a table from a wood. Here production actually stands for manufacturing. In primary

production, i.e., in agriculture and mining, the farmer does not produce wheat; the miner does not mine coal. Man co-operates with nature and extracts them. Extraction is also production. Production also takes place when a commodity is shifted from one place to another-from the region in which the commodity has lower utility to another region where it has higher utility. Transportation is also a means of production. Finally production also takes place when a commodity is stored over time, from a period when a good is not so much wanted to another period when it is wanted more. These three different types of production are generally known as the creation of form utility, place utility and time utility. In ordinary language, production refers only to the first and the term ‘trade’ or ‘commerce ‘is used for the last two. In economics, all the three are collectively called production. The farmer, manufacturer, the trader, the banker-all are producers.

PRICE MECHANISM AND CHOICE OF TECHNIQUES:

How are goods produced? This question is solved by the producers with the help of price mechanism. Every producer tries to minimize his cost, for only then can he maximize his profits. Under competitive conditions, only that producer who can adopt the most efficient method of combining factors and keep the cost of production to the minimum can hope to secure high profits. In order to reduce cost, cheaper factors of production must be used. If labour is cheaper than capital goods, production of a commodity will normally include more labour. For example, utensils can be manufactured from both aluminium and stainless steel; if however, aluminium is cheaper, producers would prefer to use it. The price system, therefore, indicates to the producers which factors of production must be chosen to make production

cheapest, given the state of technology. Every producer attempts to produce the maximum quantity of a commodity and at the minimum cost. This means that a worker who can work for 8 hrs.a day will not be allowed to remain idle or waste his time. A machine should be allowed to work for 24 hrs. a day, if it can do. In order words,

a) No factor unit will be wasted in productionb) Every factor unit will be put to that use in which its

productivity will be the highest. A man will bnot be hired as a manger monthly salary of Rs.2000/- and asked to perform the duties of a clerk who earns a monthly salary of Rs.400/-

c) Every factor will be employed up to the point at which the revenue from the last unit employed is equal to the cost on that unit. If an additional worker can contribute Rs.10 to production in a day and if he costs Rs.5/- by way of wages to the firm, it woyld be worthwhile to engage him. A firm will continue to employ more and more workers till the productivity of the last worker and the wage paid to him are equal.

If factor units are underutilized or wastefully used, total product will not be maximum; cost per unit will rise and profit will come down. On all these points, the producers are guided byu the prices of the factors they engage and also the prices of the product they help to produce. In other words, they are guided by the price system.

PRICE MECHANISM AND THE METHOD OF DISTRIBUTION:

Goods and services are produced for those who can afford to pay for them. Mr. Ram Chand, a clerk, may wish very much to buy a car, but cannot; for the very simple reason that it is beyond his means. In a free economy, goods and services are produced for those who have effective demand,

i.e., for those who have sufficient income and who are willing to pay the price. But an income on which demand depends is only another name for prices of factor services. For instance, a person may get his income by way of wages or interest is the price for the use of capital; profit is the price for the services of the organizer, and land rent is the price for the use of land. Thus effective demand depends upon money incomes which constitute part of the price mechanism. It is therefore, clear that the distribution of goods and services i.e., the problem for whom to produce-is solved on the basis of effective demand which also depends upon the price mechanism.

In a free economy, there is no visible authority who controls and directs the economic system. All the three economic problems are however, solved with the help of the price mechanism. The capitalist system of production and distribution based on the market forces of demand and supply, is considered the best and the most efficient system. It is said to bring about the most efficient allocation of resources in a country. Only those goods and services are produced which consumers want and they are produced in the required quantities. Secondly, production, though undertaken by thousand and millions of independent producers, is maximized and the cost of production is minimized.

Every economic activity is controlled, directed and guided by the price mechanism in a free enterprise economy. All the millions of prices are determined simultaneously in such a way that there exists a perfect co-ordination in the production, distribution and consumption of all goods and services. Over production, for instance, will lead to a fall in prices and curtailment of production by the producers. The

question now is whether the price system which appears effective and fool proof in theory is actually so.

EFFECTIVENESS OF PRICE MECHANISM:

Does the price mechanism really represent the wishes of the people? The answer will be in the affirmative only when income is more or less equally distributed so that people can demand goods and services freely. But this is not so in practice. Demand is made effective by those who have income and are prepared to spend it and bot by those who need goods but who lack the necessary resources. The fortunate few who have large incomes are liable to influence producers to manufacture even useless luxuries, which may tickle their fancy. The poor, on the other hand, have sometimes to go without even the necessaries of life. The price mechanism their does not bring about equal and fair distribute of goods and services among the people on the basis of their needs.

Prices, wages and profits are supposedly determined by demand and supply in free markets. In fact, however, markets are not free and competition is not perfect. In practices prices are determined and influenced by a few powerful monopolistic producers. These producers do not produce the quantity which the consumers want. Besides, the fix high prices too. As a result, market prices do not reflect demand and supply. Moreover, the tastes and fashions may change quickly and consequently there may be overproduction in some industry and underproduction in others. Often, by the time necessary adjustment in supply takes place, demand may have changed again. The price mechanism, therefore, cannot bring about the most efficient allocation of economic resources, because of the existence of monopoly element and also because of periodical business depression and unemployment. Maximum output at

minimum cost at minimum cost need not necessarily take place under the price mechanism.

The consumers themselves may sometimes be responsible for wrong allocation of resources. They may demand goods and services which do not yield real utility but which may be meant to enhance their prestige in the eyes of their neighbours. They may even demand goods, which are harmful. Consumers often prefer cheap novels to good booked and demand vulgar films and cheap and harmful liquor which tend to spoil their morals and health. Producers use advertisements to influence the tastes and preferences of consumers. It is through advertisement that even bad and positively harmful drug and medicines and other goods are sold in agree enterprise economy. Economists, therefore, argue that the price mechanism may maximize output and national income but it is not really necessary that maximum national income should automatically mean maximum national welfare also. These successes of price mechanism depend upon the existence of a stable monetary system. It may be mentioned here that all prices are expressed in terms of money, which is the medium of exchange, and of payments. Instability in the value of money will disturb the working of the economy. For instance, inflation and deflation upset production and distribution in an economy.

Question no.2

EXPLAIN MEASUREMENT OF PRICE ELASTICITY OF DEMAND.

Answer:

MEASUREMENT OF PRICE ELASTICITY OF DEMAND:

Alfred Marshall who gave us the concept of elasticity of demand has given different methods of measuring elasticity of demand, viz., point method, are method and total outlay method.

A.POINT METHOD OF MEASURING PRICE ELASTICITY OF DEMAND:

This method originally suggested by Marshall, is used to find out the elasticity of demand at a particular point on the demand curve. This method has now common demand of

measuring elasticity of demand. We draw a demand curve DD and draw line AB tangent to the demand curves in Fig 1. The slopes of DD and AB are the same between point P and P1. We find elasticity between two points P and P1 which we should assume to be close to each other. Y

A

PRICE F

G R

QUANTITIY

The formula for elasticity of demand is:

Percentage change in demand Ep= Percentage change in price

Now, the percentage change in demand can be presented as :

Change in demand x

Ep= Original demand 100

Likewise, the percentage change in price can be presented as:

Change in price

Ep= Original price x 100

The formula can, therefore, be conveniently elaborated as:

Change in demand

Original demand x100

Ep= Change in price

Original price x100

Simplifying this (and cancelling 100 on both sides), we have

Change in demand original price

Ed= Original demand x Change in price

By rearranging the above equation, we get

Change in demand Original price

Ep= Change in price x Original demand

Or

Ep= ∆q/∆p X P/Q

∆q* = Change in quantity

∆p* = change in price

P = Original price

Q = Original quantity

Now, we shall substitute the above formula, with the symbols from Fig 1.

The change in quantity (∆q) is NN1 or RP1 and change in price (∆p), is FG or PR. The change in quantity and change in price may conveniently by take from the small triangle PRP1. The original price is PN and the original quantity is ON. Now,

Ep = RP1/RP X PN/ON

Now, the smaller triangle PRP1 is similar to the bigger triangle PNB and hence the ratio of their sides will be equal, In other words,

RP1/PR = NB/PN

We can now recast the above equation by substituting NB/PN For RP1/PR

RP1/PR X PN / ON

= NB/PN = PN/ON PN IS CANCELLED

EP= NB/ON

= NB/FP (ON=FP)

We have derived the formula for elasticity of demand as NB/FP (i.e., base of the lower triangle PNB divided by the base of the upper triangle AFP). The triangle AFP is similar to triangle PNB and, therefore, the ratio of their sides is equal. This means that the perpendicular of the lower triangle (PN) divided by the perpendicular of the upper triangle (AF) or the hypotenuse of the lower triangle (PB) divided by the hypotenuse of the triangle (AP) will also be equal to NB/FP. The above equation can, therefore, be written as follows:

Ep= NB/FP or PN/AF or PB/AP

For the purpose of measuring elasticity of demand, we may use any one of the above equations, though we commonly use of the third one, viz., PB/AP. If we assume that the distance between points P and P1 in Fig 1 diminished and the two points coincide, elasticity of demand at point P on a straight lie demand curve AB will be PB/AP or the lower segment of the demand line divided by

the upper segment of the demand line.

QUESTION NO.3

DESCRIBE THE KINDS OF ECONOIC SYSTEMS

ANSWER:

KINDS OF ECONOMIES:

SIMPLE AND COMPLEX ECONOMIES:

The economy of an isolated village in which every family attempts to produce everything to satisfy all its needs is an example of a simple economy. There is very little trade or exchange. Till a few decades ago, Indian villages were self-contained and self-sufficient economies. As compared to a village economy, the economy of a city like Delhi or Bombay is extremely complex. There are lakhs of people living in these big cities. There is a continues flow of goods in and out of there cities Thousands and millions of varieties of food, clothing and other items comfort and luxury have been coming to these places from all over the country and even from foreign countries. People are dependent on one another. There is a very high degree of specialization; each man is trying to do one job or only one part of a job all his life. In a complex economy there is a high degree of specialization and extreme dependence of each one upon everyone else. If something goes wrong in one part of the economy, the entire system may collapse and it may take a long time to set it functioning smoothly again.

DEVELOPED, UNDEVELOPED AND DEVELOPING ECONOMIES:

An advanced or developed economy is one, which carries on production with a large amount of machinery and advanced techniques. An advanced economy employs its human and other resources to the maximum extent possible. The productive efficiency of a developed economy is of a very high order, the per capita income is also high. Consequently, people in these countries enjoy high standards of living, England, the U.S.A.,

France, West Germany etc., are advanced economies. These economies are inhabited by over one-fourth of the entire population of the world.

In an undeveloped economy, production is carried on with a relatively small amount of capital and with primitive and old techniques. Application of scientific and technological improvements to agriculture or industry is limited. In these countries, the level of real income and capital per head of population are extremely low and consequently people have a low standard of living. Most of the countries of Asia, with the exception of Japan, the whole of Africa, South America with the possible exceptions of Argentina, and some countries of eastern and southern Europe could be considered underdeveloped economies. These countries are inhabited by three-fourths of the entire population of the world.

CAPITALIST, SOCIALIST AND MIXED ECONOMIES:

A capitalist economy, also known as the free enterprise economy, is one in which the means of production viz. land, labour and capital are owned and managed privately. The predominant motive force of all economic activities is to maximize profit. The government does not interface in the working of the economic system except in time of national emergencies, like war, or a business depression. The socialist economy, on the other hand, is one in which all the means of production are owned and operated by the State on behalf of the community and the predominant motive force of economic activates is public welfare and not private profit. All economic activities are controlled, regulated and guided by the government according to a predetermined plan. Then we have the mixed economy;which attempts to combine the good features of both capitalism as well as socialism without the defect of either. In a mixed economy there is a private sector which is based on the profit motive and a public sector controlled by the Government.

There can be a joint sector too in which both the private and public sectors participate in share capital and management. India professes to be a mixed economy.

THE VITAL FUNCTIONS OF AN ECONOMY:

Feeding, digestion and growth are known as the vital processes of human existence. In the same way every economy has its vital processes, which are production, consumption and growth. All economies perform these three basic functions though they differ with regard to the volume of production and consumption and the rate of growth.

PRODUCTION OF GOODS AND SERVICES:

The first vital function of an economy is production, which takes place continuously. Different varieties of food and clothing, of entertainment and amusement, radios, cinemas, etc., are produced by the economy. Production and so on. According to economists, production is not complete unless the product is taken to the hands of consumer, and accordingly, production embraces trade too. The process of production continues till the product reaches the hands of the consumers.

The term ‘production’ is abroad one and it includes various kinds of production. Production may take the form of transformation of oneproduct into another, that is, from a commodity with lower utility to another commodity, which has higher utility.e.g. Production,i.e., in agriculture and mining, the farmer does not produce wheat; the miner does not money coal. Man co-operates with nature and extracts them. Extraction is also production. Production also takes place when a commodity is shifted from one place to another-from the region in which the commodity has lower utility to another region where it has higher utility. Transportation is also a means of production, These three different types of production are generally known as the creation of form utility, place utility and time utility. In ordinary language,

production refers only to the first and the term ‘trade’ or ‘commerce’ is used for the last two. In economics, all the three are collectively called production. The farmer, manufacturer, the trader, the banker-all are producers.

The modern economy is a money economy and accordingly, all those goods and services, which do not command a money value, may be excluded from production, even though they may be quite important from the point of view of welfare of the community. A good example is the services provided by women in their own houses, in the form of house hold work; their labour is productive but it is not paid for-and hence does not become part of production. The services of a maidservant will be counted under production; but the services of a housewife will be excluded.

CONSUMPTION OF GOODS AND SERVICES:

Production of goods and services has no meaning unless it is to satisfy human wants. Hence consumption, the act of satisfying one’s wants, is the second vital process of the economy. Consumption implies the using up of material goods and of immaterial services. Consumption may be of different types. There are many goods and services which are produced and consumed simultaneously, as for example, the series of doctors, waiters etc. But in many cases, there are a number of stages between productions an consumption. In the case of many finished manufactured articles, say, a cotton bush-shirt, a number

of intermediate manufacturing process may be involved, as for instance, the raw material stage, semi-finished stage, the wholesale stage and this retail stages. The goods which are in the intermediate stages are known as investment goods. There are some goods, which are not consumed away, but continue to provide services for long periods, that is, as long as they are available. These are durable consumer goods-“long-lived goods”-such as cars, refrigerators, furniture, houses, clothes, etc. It is difficult to estimate how much service a person secures from the consumption of durable goods in any period, say, a month. Economists, therefore, include these goods under the category of consumption at the moment they are brought by the consumers.

GROWTH:

Unless an economy grows by using its resources to their fullest extent, it will become stagnant, In a growing economy, the rate of output staidly increases. The rate of growth should exceed the rate of increase in population of the country. Thus, a growing economy will ultimately mean an increase in the country’s per capita income. A developing economy allocates part of the resources for the production of capital goods which in turn, will produce other goods. The greater the size of capital stock of the country, the larger will be the income of the community. The capital goods refer to machinery, factory buildings, transport systems etc. Those capital goods which can be used over a period of years are known as fixed investment goods or fixed capital goods when in course of time these goods become worse or obsolete, they have to be repaired or replaced. This is known as “maintaining capital intact”. A developing economy should devote its resources not only to maintain capital, but also to accumulate capital.

Thus the vital functions of the economy are of three types-production, consumption and investment. Every economy has these three vital processes, though they may differ with regard to

the volume of production and consumption and the rate of growth. In a capitalist economy, these functions are performed by individuals and institutions without the interference or guidance of the government. For instance, individuals and institutions decide what goods and services to produce and in what quantities. In a socialist economy, these processes are organised and planned by the Government. While in agree economy, the price system and the circulation of money are important to enable people to demand and supply various goods and services; they are of subsidiary importance in a socialist system.

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QUESTION NO.4

PRICE MACHANISM ALSO KNOWN AS THE MARKET MARKET MACHANISAM , THAT HELPS TO SOLVE THE CENTRAL PROBLEMS IN CAPITALIST ECONOMY.EXPLAIN.

ANSWER:

Central problems of An Economy:

All economies face three fundamental or basic central economic problems. These three problems are made well known by prof. Samuel son’s phrase “what, how and for whom”

(a) What goods and what varieties should be produced, and in what quantities should they be produced?

(b) How should they be produced?

(c) For who are these goods and services produced or who will consume them?

WHAT TO PRODUCE:

Prof. Robbins very clearly demonstrates that human wants are unlimited but the resources available to satisfy them are limited. If an economy has unlimited wants and equally unlimited resources to satisfy them, then there will be no economic problem. For, whatever the economy requires-whether it its food, clothing, shelter or entertainment-can be satisfied fully. This, however, is not the case. Economic resources or means of production are not only limited but have alternative uses. The economy will, therefore, have to decide what goods and services should be produced, and in what quantities they should be produced.

In a full employment economy, in which all factor services are employed in some line or the other, the production of additional quantities of any commodity can only be at the expense of some other commodity. For instance, the production of more sugar is possible only at the expense if rice or wheat. If more men are required in the cotton textile industry because of greater demand for cotton goods workers will have to be diverted from some other industry or industries.

HOW ARE GOODS TO BE PRODUCED?

Suppose that an economy has decided to produce certain goods and services. The economy has then to decide how these goods and services will be produced. This is the problem of production and it depends upon three factors, viz.,

(a) The extent of resources available to the economy in terms of nature resources, labour and capital

(b) The quality of efficiency of these factors of production and

(c) The nature of technology available to the community.

At any particular time, these three conditions may be assumed to be constant. Hence, the total amount of production of any commodity will be fixed. For instance, it is possible to bring in additional land under cultivation; labour supply may increase through an increase in population and capital supply can be changed through increased manufacture of implements tools and machinery. At the same time, the efficiency of factors of production can also be improved and the state of technology can be raised through innovations and inventions.

At any given time, every economy must decide(a) how its limited resources-viz. land, labour, and capital-can be used to achieve maximumproduction and (b) how these resources themselves can be increased so as to produce more for the future. The economy must decide about the number and kind of labour to be used, the quantity of capital to be utilized, the amount of land to be combined with other factors, and so on. The objective of an economy is to produce the maximum quantity of goods of the best quality and the minimum cost possible.

Every economy has thus to choose between different goods and services, as resources at its disposal are limited and do not permit the production of all goods. How goods are services are produced will depend upon the state of technology in the country, quantity and quality of factors and the manner in which the factors of production are combined and organized. At this stage, a third basic problem arises: For whom are all these goods and services produced?

FOR WHOM ARE THE GOODS PRODUCED?

Obviously goods and services are produced for the people, and more specifically, for those how have the necessary means to pay for them. One cannot have everything one requires. If that were possible, there will be no economic problem. In every society, the production and supply of goods is always smaller than the demand for them. Hence, the economy should evolve some method by which it can distribute the goods produced among the people. In a dictatorship, it may be possible for the government to allocate goods and services according to the wishes of the dictator or according to some principle of equal division. In a pure capitalist enterprise economy, goods and services are distributed among those who can pay for them.

Every economy seeks to solve these three central problems in its own way. That economy which can solve these problems in the most efficient and effective manner will be preferred to others.

CENTRAL PROBLEMS AND THE PRICE MECHANISM:

Every commodity has its own price determined by its demand and supply in a free market. There are as many prices as there are goods and factors of production. All the prices are collectively called the price mechanism or the price system. The price mechanism requires the existence of free market forces of demand and supply. The price mechanism, also known as the

market mechanism, helps to solve the central problems in capitalist economy.

PRICE MECHANISM AND CHOICE OF TECHNIQUES:

How are goods produced? This question is solved by the producers with the help of price mechanism. Every producer tries to minimize his cost, for only then can he maximize his profits. Under competitive conditions, only that producer who can adopt the most efficient method of combining factors and keep the cost of production to the minimum can hope to secure high profits. In order to reduce cost, cheaper factors of production must be used. If labour is cheaper than capital goods, production of a commodity will normally include more labour. For example, utensils can be manufactured from both aluminium and stainless steel; if however, aluminium is cheaper, producers would prefer to use it. The price system, therefore, indicates to the producers would prefer to use it. The price system, therefore, indicates to the producers which factors of production must be chosen to make production cheapest, given the state of technology. Every producer attempts to produce the maximum quantity of a commodity and at the minimum cost. This means that a worker who can work for 8hrs a day will not be allowed to remain idle or waste his time. A machine should be allowed to work for 24 hours a day, if it can do. In order words,

a) No factor unit will be wasted in production

b) Every factor unit will be put to that use in which its productivity will be the highest. A man will not be hired as a manager monthly salary of Rs.2,000/- and asked to perform the duties of a clerk who earns a monthly salary of Rs.400/-

c) Every factor will be employed up to the point at which the revenue from the last unit employed is equal to the cost on

that unit. If an additional worker can contribute Rs.10 to production in a day and if he costs Rs.5/- by way of wages to the firm, it would be worthwhile to engage him. A firm will continue to employ more and more workers till the productivity of the last worker and the wage paid to him are equal.

If factor units are underutilized or wastefully used, total product will not be maximum; cost per unit will rise and profit will come down. On all these points, the producers are guided by the prices of the factors they engage and also the prices of the product they help to produce. In other words, they are guided by the price system.

QUESTION NO.5

WHAT ARE THE FACTORS GOVERNING PRICE ELASTICITY OF DEMAND ? EXPLAIN.

Answer:

FACTORS GOVERNING PRICE ELASTICITY OF DEMAND:

A change in the quantity of a commodity sold in market may come about through: (a) change in the average quantity purchased by each consumer, (b) change in the number of consumers, and (c) change in both. Sometimes, a change in price is followed by a marked change in the quantity demanded and consumed; while, in some cases, the effect may be only slight. Why is the demand for a particular commodity more or less elastic than the demand for other commodities?

Existence of substitutes:

The most important factor on which elasticity of demand for a product depends is the existence of substitutes for the product. The demand for commodity is said to be elastic if the commodity has substitutes and if it can be easily replaced. Even a small rise in its price will induce buyers to go in for its substitutes who prices have remained the same; on the other hand, a fall in its price will induce more people to buy this commodity than its substitutes. Most people regard coffee and tea as reasonable substitutes. If price of coffee rises, it will induce many people to shift to and buy more tea. Or, suppose there are different brands of cigarettes all of which are substitutes for each other. The demand for any particular brand will be elastic, for a rise in price of one brand will induce consumers to shift their demand to the other brands of cigarettes.

An aspect of substitution and its influence on elasticity of demand relates to the number of uses as well as the nature of uses of a product. The demand for a product is said to be more elastic if the product has several uses, rather than only one use. If the price of a product, which has a number of uses, forexample, coal or steel,falls,it will induce the consumption of the goods in all its uses. Even though the fall in price may have only a small effect on its consumption for each purpose, the aggregate effect will be a substantial change in total demand. Again, at a high price, elasticity, for example, may be used only for lighting where

its utility is high; when its price comes down, the demand for elasticity may increase, it may be used for cooking,etc. a rise in the price of electricity, on the other hand, will tend to restrict its consumption only to those uses possessing the highest utility. It is also possible that the demand for a commodity which has a variety of uses may be elastic in some uses and inelastic in some other uses. In India, coal is used by railways for the generation of steam power and in homes as fuel. Even if the price of coal rises, the railways will continue to use it; but consumers may give it up and take to alternative domestic fuels. In other words, the demand for the commodity in those uses where marginal utility is high will be inelastic, while in those uses where the marginal utility is low, the demand will be elastic.

The demand for necessities is inelastic, while demand for luxuries is usually elastic. This is so because certain things which are essential in life will demand whatever be their price. Hence, a rise or fall in the price of an essential commodity does not ordinarily affect, in any appreciable manner, the amount of goods bought. On the other hand, comforts and luxuries can be easily given up and, therefore, arise in their prices will result in the reduction of the demand for them, while a fall in their prices will lead to the expansion of demand for them. It is not always true, however, that the demand for luxuries is always elastic and that of necessaries always inelastic. In the case of high-priced luxuries like diamonds, the demand will be comparatively inelastic because the price is so high that only the very rich can buy them. A change in their price either way will not affect the demand for them. Similarly, in the case of such luxuries as cars, scooters, television sets etc., the demand will tend to be elastic, since the demand for then comes under more or less conventional necessaries and hence those who want to buy them will do so whether price rises of falls.

To a large extent, goods are considered necessary because they do not have suitable substitutes. Salt is a necessity because there is no substitute for slat. It is possible to argue that demand for salt is inelastic, not because it is necessary but because there is no good substitute for it. It is true that to a large extent the possibility of substitution shows or reveals whether a commodity is a necessity or a luxury.

In this connection it may be argued that demand for a commodity is said to be elastic if the demand for it can be postponed. The demand for woollen goods may be postponed, if their price goes up but the demand for rice or wheat cannot be so postponed. Hence the demand for the former is said to be inelastic. But then the commodity whose demand cannot be postponed is a necessary commodity, while that commodity the demand for which can be easily postponed usually is luxury, or semi-luxury or comfort.

Durability of the Commodity:

Secondly, the elasticity of demand depends on the durability of the commodity and the time interval for which the demand schedule is relevant. When goods are durable and can be used for a number of years individual consumers are not in the market for additional units for a considerable number of years after they have made a purchase. Hence, a higher or lower price for durable goods will generally not effect demand for them. In other words, the demand for durable goods will generally be inelastic over a long period of time. In the case of non-durable goods, the consumers can adjust their rates PF purchase at any time and thus the demand for them is more sensitive to price changes. That is to say, the demand for non-durable goods is normally more elastic. The argument may be presented in another way too:

If the price of durable goods-say, cars-rises, the average consumer will try to maintain the old car for a longer period instead of purchasing a new one. On the other hand, a fall in the price of cars will induce him to discard in favour of a new one earlier than he would normally dose. Thus,the greater the durability of a product, the greater the incentive to the customer to lengthen its working life or reduce it in response to rise in price or fall in price. In such a case, the demand for a durable product will be elastic.

The elasticity of demand for a commodity depends on the proportion of income, which a consumer generally spends on them. The consumer’s expenditure on slat or matches is so small and constitutes such a small fraction of his total income that even a rise of 50% in their will not induce the consumer to cut down his expenditure on these items; demand is inelastic for such goods. The same cannot be said of such items as clothing on which the consumer spends a considerable part of his total income. Hence elasticity of demand depends not only upon the nature of the commodity but also upon the proportion of income which a consumer usually spends on it.

Range of Prices:

Finally, the elasticity of demand for a product will depend on the range of prices. At a very high or very low range of prices, demand tends to be inelastic. When the price of a commodity is very high, the demand for it comes from only a small section of people in the country, viz., and the rich people. A change in price in either direction will not greatly affect the demand of the rich consumers. If, one the other hand, the price of a commodity is very low, all those who want to buy it will do so and will buy desired quantities. Accordingly, a change in price in either direction will not greatly affect the quantity. Thus, at very high or very low prices, elasticity of demand tends to be low. On the other hand, at middle range of prices, demand tends to be elastic

because a rise or fall in price will affect the demand of a large number of persons.

SIGNIFICANCE OF PRICE ELASTICITY OF DEMAND:

In a free capitalist economy, the entire volume of output is directed and controlled by consumer demand. If production is to be profitable, the volume of output of goods and service produced must be adjusted in terms of the available demand for them. Consumer demand exercises a major influence upon producer’s demand for factors of production, and thus effects the distribution of factors in various lines of production.

Every seller must consider the elasticity of the total demand curve when he is contemplating a change in price-for; the elasticity of demand shows the responsiveness of his sales to a change in his price. The only exception is perfect competition where the firm can assume a perfectly elastic demand curve for it product. It should be remembered that elasticity of demand is not the only factor which the individual producer considers when contemplating a change in price; he also considers such factors as the reaction of his competitors to his price changes.

The concept of demand is also important since it enables the Government to decide which particular industries should be declared public utilities and consequently be owned and operated by the state. Public utilities are vested with a public interest and hence it is desirable that those industries for whose products demand is inelastic and which are the same time controlled by monopoly interests large extent, depends upon the products of public utilities and the combination of inelastic demand with a decided element of monopoly gives to these enterprise a special sort of public interest-an interest that flows from the fear of restricted output and high prices.