Elasticity of demand curves
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This document defines and explains different concepts related to elasticity of demand. It discusses: - The definition of elasticity of demand as the percentage change in quantity demanded due to a percentage change in price. - Methods to measure elasticity including the total outlay method, percentage method, point elasticity, arc elasticity, and geometric method. - Examples are given to show elasticity equal to 1, less than 1, and greater than 1. - Income elasticity of demand and cross elasticity of demand are also defined.
Elasticity of demand curves
- 2. Elasticity of Demand • Percentage change in the Quantity demanded of a good due to percentage change in the price of the good is called elasticity of demand. Or • Degree of responsiveness or sensitivity of quantity demand of a good due to change in the price of the good is called price elasticity of demand. ηd= 𝐸 𝑑 = 𝑃𝑒𝑟𝑐𝑒𝑛𝑡𝑎𝑔𝑒 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑡ℎ𝑒 𝑞𝑢𝑎𝑛𝑡𝑖𝑡𝑦 𝑑𝑒𝑚𝑎𝑛𝑑 𝑜𝑓 𝑡ℎ𝑒 𝑔𝑜𝑜𝑑 𝑃𝑒𝑟𝑐𝑒𝑛𝑡𝑎𝑔𝑒 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑡ℎ𝑒 𝑝𝑟𝑖𝑐𝑒 𝑜𝑓 𝑡ℎ𝑒 𝑔𝑜𝑜𝑑
- 3. Methods to Measure Elasticity of Demand Methods to measure Elasticity of Demand Total Outlay Method Percentage method Point Elasticity Arc Elasticity Geometric Method
- 4. Total Outlay (Expenditure) Method Under this method total expenditure made on the good before change in price and after change price are compared. If Total Expenditure remain Same then Elasticity of demand is equal to one. If Total Expenditure increases, then Elasticity of demand is Greater than one. If Total Expenditure decreases, then Elasticity of demand is less than one. Ed = 𝑇𝑜𝑡𝑎𝑙 𝐸𝑥𝑝𝑒𝑛𝑑𝑖𝑡𝑢𝑟𝑒 𝑎𝑓𝑡𝑒𝑟 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑝𝑟𝑖𝑐𝑒 𝑇𝑜𝑡𝑎𝑙 𝑒𝑥𝑝𝑒𝑛𝑑𝑖𝑡𝑢𝑟𝑒 𝑏𝑒𝑓𝑜𝑟𝑒 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑝𝑟𝑖𝑐𝑒 According to this method, by comparing the total expenditures of the consumer both before and after change in price of a product, it can be known whether demand elasticity for product is one, less than one or more than one.
- 5. Price Qd Total Expenditure 40 6 240 20 8 160 Price Qd Total Expenditure 40 6 240 20 18 360 ηd = 1 ηd < 1 ηd > 1 Price Qd Total Expenditure 40 6 240 20 12 240 Total Outlay (Expenditure) Method
- 6. The Demand Curve having Elasticity equal to one. (=1) D D 40 20 126 Qd P As the price decreases from 40 to 20 The quantity increases from 6 units to 12 units. The Change in the quantity is proportional to change in the price. 0 Price Qd Total Expenditure 40 6 240 20 12 240 ηd = 1
- 7. The Demand Curve having Elasticity less than one. (<1) D D 40 20 86 Qd P As the price decreases from 40 to 20, The quantity increases from 6 to 8 units. The percentage Change in the quantity is less than percentage change in the price. 0 Price Qd Total Expenditure 40 6 240 20 8 160 ηd < 1
- 8. The Demand Curve having Elasticity greater than one. (>1) D D 40 20 186 Qd P As the price decreases from 40 to 20, The quantity demanded increases from 6 to 18. The percentage Change in the quantity is greater than percentage change in the price. Price Qd Total Expenditure 40 6 240 20 18 360
- 9. 6 Qd D D 40 20 12 P 0 ηd = 1 D D 40 20 86 Qd P 0 ηd < 1 D D 40 20 186 Qd P ηd > 1 Total Outlay (Expenditure) Method ηd = 1 Vs ηd < 1 Vs ηd > 1
- 10. Percentage Method (Formula / Priori / Mathematical/ Arithmetical / Proportionate ) ηd= 𝐸𝑑 = 𝑃𝑒𝑟𝑐𝑒𝑛𝑡𝑎𝑔𝑒 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑡ℎ𝑒 𝑞𝑢𝑎𝑛𝑡𝑖𝑡𝑦 𝑑𝑒𝑚𝑎𝑛𝑑 𝑜𝑓 𝑡ℎ𝑒 𝑔𝑜𝑜𝑑 𝑃𝑒𝑟𝑐𝑒𝑛𝑡𝑎𝑔𝑒 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑡ℎ𝑒 𝑝𝑟𝑖𝑐𝑒 𝑜𝑓 𝑡ℎ𝑒 𝑔𝑜𝑜𝑑 Percentage change in the Quantity demanded of a good due to percentage change in the price of the good is called elasticity of demand. Percentage method Point Elasticity Arc Elasticity
- 11. Percentage Method (Formula / Priori / Mathematical/ Arithmetical / Proportionate ) Percentage change in the Quantity demanded of a good due to very small change in the price of the good. Such that apparently there is only one point on the demand curve, is called point elasticity of demand. Point Elasticity of Demand D D P1 P2 Q2Q1 Qd P 0
- 12. Percentage Method (Formula / Priori / Mathematical/ Arithmetical / Proportionate ) = 𝑄2 − 𝑄1 𝑄 𝑃2 − 𝑃1 𝑃 = ∆𝑄 𝑄 ∆𝑃 𝑃 = ∆𝑄 𝑄 × 𝑃 ∆𝑃 = ∆𝑄 ∆𝑃 × 𝑃 𝑄 Percentage change in the Quantity demanded of a good due to very small change in the price of the good. Such that apparently there is only one point on the demand curve, is called point elasticity of demand. Point Elasticity of Demand ηd= 𝐸𝑑 = 𝑃𝑒𝑟𝑐𝑒𝑛𝑡𝑎𝑔𝑒 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑡ℎ𝑒 𝑞𝑢𝑎𝑛𝑡𝑖𝑡𝑦 𝑑𝑒𝑚𝑎𝑛𝑑 𝑜𝑓 𝑡ℎ𝑒 𝑔𝑜𝑜𝑑 𝑃𝑒𝑟𝑐𝑒𝑛𝑡𝑎𝑔𝑒 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑡ℎ𝑒 𝑝𝑟𝑖𝑐𝑒 𝑜𝑓 𝑡ℎ𝑒 𝑔𝑜𝑜𝑑 = 𝑄2 −𝑄1 𝑄 ×100 𝑃2 −𝑃1 𝑃 ×100 D D P1 P2 Q1 Q P 0 Q2
- 13. Percentage Method (Formula / Priori / Mathematical/ Arithmetical / Proportionate ) = 𝑄2 − 𝑄1 𝑄2 + 𝑄1 2 𝑃2 − 𝑃1 𝑃2 + 𝑃1 2 = ∆𝑄 𝑄2 + 𝑄1 ∆𝑃 𝑃2 + 𝑃1 = ∆𝑄 𝑄2 + 𝑄1 × 𝑃2 + 𝑃1 ∆𝑃 = ∆𝑄 ∆𝑃 × 𝑃2 + 𝑃1 𝑄2 + 𝑄1 Percentage change in the Quantity demanded of a good due to comparatively significant large change in the price of the good. Such that there appear two distinct points on the demand curve, is called Arc elasticity of demand. Arc Elasticity of Demand ηd= 𝐸𝑑 = 𝑃𝑒𝑟𝑐𝑒𝑛𝑡𝑎𝑔𝑒 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑡ℎ𝑒 𝑞𝑢𝑎𝑛𝑡𝑖𝑡𝑦 𝑑𝑒𝑚𝑎𝑛𝑑 𝑜𝑓 𝑡ℎ𝑒 𝑔𝑜𝑜𝑑 𝑃𝑒𝑟𝑐𝑒𝑛𝑡𝑎𝑔𝑒 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑡ℎ𝑒 𝑝𝑟𝑖𝑐𝑒 𝑜𝑓 𝑡ℎ𝑒 𝑔𝑜𝑜𝑑 = 𝑄2 −𝑄1 𝑄2+𝑄1 2 ×100 𝑃2 −𝑃1 𝑃2+𝑃1 2 ×100 D D P1 P2 Q2Q1 Qd P 0 A B
- 14. Geometric Method Geometric method was suggested by Prof. Marshall and is used to measure the elasticity at a point on the demand curve. When there are infinitely small changes in price and demand, then the ‘Geometric Method’ is used. This method is also known as ‘Graphic Method’ or ‘Point Method’ or ‘Arc Method’. Elasticity of demand (Ed) is different at different points on the same straight line demand curve. In order to measure Ed at any particular point, lower portion of the curve from that point is divided by the upper portion of the curve from the same point. 𝐸𝑑 = Lower segment of demand curve (LS) Upper segment of demand curve (US) P Q Quantity Demand Price 0 N
- 15. ηd= 𝐸𝑑 = Lower segment of demand curve (LS) Upper segment of demand curve (US) E D Quantity Demand Price 0 B A C Ed = 1 Ed < 1 Ed > 1 Ed = ∞ Ed = 0 Geometric Method
- 16. Two Extremes of Elasticity of Demand 1 Perfectly inelastic demand: The Demand Curve having Elasticity equal to zero (=0) 2 Perfectly Elastic Demand: The Demand Curve having Elasticity equal to infinity (=)
- 17. The Demand Curve having Elasticity equal to zero (=0) As the price decreases from P1 to P2 The quantity do not change. There is no Change in the quantity as price changes from P1 to P2. Perfectly inelastic demand D D Price P1 Q 0 P2 Quantity Demand
- 18. The Demand Curve having Elasticity equal to infinity (=) D D P Q1Q Quantity Demanded Price At a certain price the quantity increases from Q to Q1. There is no change in the price while there is change in the quantity from Q to Q1. Perfectly elastic demand
- 19. Income Elasticity of demand Percentage change in the Quantity demanded of a good due to percentage change in the income of the consumer is called Income elasticity of demand. = 𝑄2 − 𝑄1 𝑄2 + 𝑄1 2 𝑌2 − 𝑌1 𝑌2 + 𝑌1 2 = ∆𝑄 𝑄2 + 𝑄1 ∆𝑌 𝑌2 + 𝑌1 = ∆𝑄 𝑄2 + 𝑄1 × 𝑌2 + 𝑌1 ∆𝑌 = ∆𝑄 ∆𝑌 × 𝑌2 + 𝑌1 𝑄2 + 𝑄1 ηY= 𝐸 𝑌 = 𝑃𝑒𝑟𝑐𝑒𝑛𝑡𝑎𝑔𝑒 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑡ℎ𝑒 𝑞𝑢𝑎𝑛𝑡𝑖𝑡𝑦 𝑑𝑒𝑚𝑎𝑛𝑑 𝑜𝑓 𝑡ℎ𝑒 𝑔𝑜𝑜𝑑 𝑃𝑒𝑟𝑐𝑒𝑛𝑡𝑎𝑔𝑒 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑡ℎ𝑒 𝐼𝑛𝑐𝑜𝑚𝑒 𝑜𝑓 𝑡ℎ𝑒 𝐶𝑜𝑛𝑠𝑢𝑚𝑒𝑟 = 𝑄2 −𝑄1 𝑄2+𝑄1 2 ×100 𝑌2 −𝑌1 𝑌2+𝑌1 2 ×100
- 20. Cross Elasticity of demand Percentage change in the Quantity demanded of a good due to percentage change in the price of its substitute or complementary good is called cross elasticity of demand. ηX= 𝐸 𝑋 = 𝑃𝑒𝑟𝑐𝑒𝑛𝑡𝑎𝑔𝑒 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑡ℎ𝑒 𝑞𝑢𝑎𝑛𝑡𝑖𝑡𝑦 𝑑𝑒𝑚𝑎𝑛𝑑 𝑜𝑓 𝑔𝑜𝑜𝑑 𝐴 𝑃𝑒𝑟𝑐𝑒𝑛𝑡𝑎𝑔𝑒 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑡ℎ𝑒 𝑝𝑟𝑖𝑐𝑒 𝑜𝑓 𝑔𝑜𝑜𝑑 𝐵 = 𝑄2𝐴 − 𝑄1𝐴 𝑄2𝐴 + 𝑄1𝐴 𝑃2𝐵 − 𝑃1𝐵 𝑃2𝐵 + 𝑃1𝐵 = ∆𝑄𝐴 𝑄2𝐴 + 𝑄𝐴 ∆𝑃𝐵 𝑃2𝐵 + 𝑃1𝐵 = ∆𝑄𝐴 𝑄2𝐴 + 𝑄1𝐴 × 𝑃2𝐵 + 𝑃1𝐵 ∆𝑃𝐵 = ∆𝑄𝐴 ∆𝑃𝐵 × 𝑃2𝐵+𝑃1𝐵 𝑄2𝐴+𝑄1𝐵 = 𝑄2𝐴 − 𝑄1𝐴 𝑄2𝐴 + 𝑄1𝐴 2 × 100 𝑃2𝐵 − 𝑃1𝐵 𝑃2𝐵 + 𝑃1𝐵 2 × 100
- 21. 0 < E < (for absolute values of elasticity) Unit ElasticPerfectly Inelastic Perfectly Elastic ElasticInelastic E = 1 E = 0 E < 1 E >1 E = ∞ P Qd Qd Qd Qd Qd P P P P