Assignment

Types of Elasticity of Demand:







The quantity of a commodity demanded per unit of time depends upon various factors such as the price of a commodity, the money income of the prices of related goods, the tastes of the people, etc., etc. Whenever there is a change in any of the variables stated above, it brings about a change in the quantity of the commodity purchased over a specified period of time. The elasticity of demand measures the responsiveness of quantity demanded to a change in any one of the above factors by keeping other factors constant. When the relative responsiveness or sensitiveness of the quantity demanded is measured to changes, in its price, the elasticity is said be price elasticity of demand. When the change in demand is the result of the given change in income, it is named as income elasticity of demand. Sometimes, a change in the price of one good causes a change in the demand for the other. The elasticity here is called cross electricity of demand. The three main types of elasticity are now discussed in brief.





(1) Price Elasticity of Demand:







The concept of price elasticity of demand is commonly used in economic literature. Price elasticity of demand is the degree of responsiveness of quantity demanded of a good to a change in its price. Precisely, it is defined as the ratio of proportionate change in the quantity demanded of a good caused by a given proportionate change in price. The formula for measuring price elasticity of demand is:







Price Elasticity = Percentage in quantity demand



Percentage change in price







Δq x 100



Ep = q



ΔP x 100



P



= Δq / q ÷ ΔP / P







Ep = Δq / ΔP x P / q (For simple calculation)







Example. Let us suppose that price of a good falls from $10 per unit to $9 per unit in a day. The decline in price causes the quantity of the good demanded to increase from 125 units to 150 units per day, The price elasticity using the simplified formula will be:







Ep = Δq / ΔP x P / q



Δq = 150 - 125 = 25 ΔP = 10 - 9 = 1



Original quantity = 125 Original price = 10







Ep = 25 / 1 x 10 / 125 = 2. The elasticity coefficient is greater than one.







Therefore the demand for the good is elastic.







The concept of price elasticity of demand can be used to divide the goods in to three groups.







(i) Elastic. When the percent change in quantity of a good is greater than the percent change in its price, the demand is said to be elastic. When elasticity of demand is greater than one, a fall in price increases the total revenue (expenditure) and a rise in price lowers the total revenue (expenditure).



(ii) Unitary elasticity. When the percentage change in the quantity of a good demanded equals percentage in its price, the price elasticity of demand is said to have unitary elasticity. When elasticity of demand is equal to one or unitary, a rise or fall in price leaves total revenue unchanged.



(iii) Inelastic. When the percent change in quantity of a good demanded is less than the percentage change in its price, the demand is called inelastic. When elasticity of demand is inelastic or less than one, a fall in price decreases total revenue and a rise in its price increases total revenue.





(2) Income Elasticity of Demand:







Income is an important variable affecting the demand for a good. When there is a change in the level of income of a consumer, there is a change in the quantity demanded of a good, other factors remaining the same. The degree of change or responsiveness of quantity demanded of a good to a change in the income of a consumer is called income elasticity of demand. Income elasticity of demand can be defined as the ratio of percentage change in the quantity of a good purchased, per unit of time to a percentage change in the income of a consumer. The formula for measuring the income elasticity of demand is the percentage change in demand for a good divided by the percentage change in income. Putting this in symbol gives.











Ey = Percentage change in demand



Percentage change in income







Simplified formula:



Ey = Δq / Δy x y / q







A simple example will show how income elasticity of demand can be calculated. Let us assume that the income of a person is $4000 per month and he purchases six CD's per month. Let us assume that the monthly income of the consumer increase to $6000 and the quantity demanded of CD's per month rises to eight The elasticity of demand for CD's will be calculated as under:







Δq = 8 - 6 = 2 Δy = $6000 - $4000 = $2000







Original quantity demanded = 6 Original income $4000







Ey = Δq / Δy x y / q = 2 / 200 x 4000 / 6 = 0.66







The income elasticity is .66 which is less than one.







Categories of income elasticity. When the income of a person increases, his demand for goods also changes depending upon whether the good is a normal good or an inferior good. For normal goods, the value of elasticity is greater than zero but less than one. Goods with an income elasticity of less than 1 are called inferior goods. For example, people buy more food as their income rises but the % increase in its demand is less than the % increase in income.





(3) Cross Elasticity of Demand:







The concept of cross elasticity of demand is used for measuring the responsiveness of quantity demanded of a good to changes in the price of related goods. Cross elasticity of demand is defined as the percentage change in the demand of one good as a result of the percentage change in the price of another good.. The .formula for measuring, cross, elasticity of demand is:







Exy = % change ^n quantity demanded of good X



% change in price of good Y







The numerical value of cross elasticity depends on whether the two goods in question are substitutes, complements or unrelated.







(i) Substitute goods. When two goods are substitute of each other, such as coke and Pepsi, an increase in the price of one good will lead to an increase in demand for the other good. The numerical value of goods is positive For example there are two goods. Coke and Pepsi which are close substitutes. If there is increase in the price of Pepsi called good y by 10% and it increases the demand for Coke called good X by 5%, the cross elasticity would be = %Δqdx / %Δpy = 0.2 . Since Exy is positive (E > 0), therefore, Coke and Pepsi are close substitutes.







(ii) Complementary goods. However, in case of complementary goods such as car and petrol, cricket bat and ball, a rise in the price of one good say cricket bat by 7% will bring a fall in the demand for the balls (say by 6%). The cross elasticity of demand which are complementary to each other is, therefore, 6% / 7% = 0.85 (negative).







(iii) Unrelated goods. The two goods which a re unrelated to each other, say apples and pens, if the price of apple rises in the market, it is unlikely to result in a change in quantity demanded of pens. The elasticity is zero of unrelated goods.

 

The law of demand explains the functional relationship between price and demand. In fact, the demand for a commodity depends not only on the price of a commodity but also on other factors such as income, population, tastes and preferences of the consumer. The law of demand assumes these factors to be constant and states the inverse price-demand relationship. Barring certain exceptions, the inverse price- demand relationship holds good in case of the goods that are bought and sold in the market.

The law of demand explains the direction of a change as it states that with a rise in price the demand contracts and with a fall in price it expands. However, it fails to explain the extent or magnitude of a change in demand with a given change in price. In other words, the law of demand merely shows the direction in which the demand changes as a result of a change in price, but does not throw any light on the amount by which the demand will change in response to a given change in price. Thus, the law of demand explains the qualitative but not the quantitative aspect of price- demand relationship.

Although it is true that demand responds to change in price of a commodity, such response varies from commodity to commodity. Some commodities are more responsive or sensitive to change in price while some others are less. The concept of the elasticity of demand has great significance as it explains the degree of responsiveness of demand to a change in price. It thus elaborates the price-demand relationship. The elasticity of demand thus means the sensitiveness or responsiveness of demand to a change in price.

According to Marshall, “the elasticity (or responsiveness) of demand in a market is great or small accordingly as the demand changes (rises or falls) much or little for a given change (rise or fall) in price.”

From the above discussion, it will be clear that thought different commodities react to a change in price in the same direction; the degree of their response differs. Demand for some commodities is more sensitive or responsive to a change in price, while it is less responsive for some others. Elasticity of demand is a measure of relative changes in the amount demanded in response to a small change in price. Certain goods are said to have an elastic demand while others have an inelastic demand. The demand is said to be elastic when a small change in price brings about considerable change in demand. On the other hand, the demand for a good is said to be inelastic when a change in price fails to bring about significant change in demand.

The concept of elasticity can be expressed in the form of an equation as:

Ep = [Percentage change in quantity demanded / Percentage change in the price]

Types of Price Elasticity

The concept of price elasticity reveals that the degree of responsiveness of demand to the change in price differs from commodity to commodity. Demand for some commodities is more elastic while that for certain others is less elastic. Using the formula of elasticity, it possible to mention following different types of price elasticity:

1. Perfectly inelastic demand (ep = 0)

2. Inelastic (less elastic) demand (e < 1)

3. Unitary elasticity (e = 1)

4. Elastic (more elastic) demand (e > 1)

5. Perfectly elastic demand (e = ∞)

1. Perfectly inelastic demand (ep = 0)

This describes a situation in which demand shows no response to a change in price. In other words, whatever be the price the quantity demanded remains the same. It can be depicted by means of the alongside diagram.

The vertical straight line demand curve as shown alongside reveals that with a change in price (from OP to Op1) the demand remains same at OQ. Thus, demand does not at all respond to a change in price. Thus ep = O. Hence, perfectly inelastic demand. Fig a

2. Inelastic (less elastic) demand (e < 1)

In this case the proportionate change in demand is smaller than in price. The alongside figure shows this type.

In the alongside figure percentage change in demand is smaller than that in price. It means the demand is relatively c less responsive to the change in price. This is referred to as an inelastic demand. Fig e

3. Unitary elasticity demand (e = 1)

When the percentage change in price produces equivalent percentage change in demand, we have a case of unit elasticity. The rectangular hyperbola as shown in the figure demonstrates this type of elasticity. In this case percentage change in demand is equal to percentage change in price, hence e = 1. Fig c

4. Elastic (more elastic) demand (e > 1)

In case of certain commodities the demand is relatively more responsive to the change in price. It means a small change in price induces a significant change in, demand. This can be understood by means of the alongside figure.

It can be noticed that in the above example the percentage change in demand is greater than that in price. Hence, the elastic demand (e>1) Fig d

5. Perfectly elastic demand (e = ∞)

This is experienced when the demand is extremely sensitive to the changes in price. In this case an insignificant change in price produces tremendous change in demand. The demand curve showing perfectly elastic demand is a horizontal straight line. Fig b

It can be noticed that at a given price an infinite quantity is demanded. A small change in price produces infinite change in demand. A perfectly competitive firm faces this type of demand.