This document discusses elasticity of demand, including what it is, types of elasticity (price, income, cross), and factors that affect it. It provides definitions and formulas for price elasticity, income elasticity, and cross elasticity. Methods for calculating elasticity are described, including ratio, point, arc, and total outlay methods. Uses of understanding elasticity for businesses and governments are outlined. A case study on health clubs explores how price and income elasticity apply in that market.
2. Content
• What is Elasticity of Demand
• Degrees of Elasticity of Demand
• Types of Elasticity of Demand
Price Elasticity of Demand
Cross Elasticity of Demand
Income Elasticity of Demand
• Method of calculating Elasticity of Demand
• Factors affecting Elasticity of Demand
• Uses of Elasticity of Demand
• Case Study
3. What is Elasticity of Demand?
• How sensitive the demand for a good is to the
changes in other economic variables, such as the
prices and consumer income.
• ep= % change in quantity of a good demanded
% change in another economic variable
• A higher demand elasticity for a particular economic
variable means that consumers are more responsive
to changes in this variable, such as price or
income.
7. Types of Elasticity of Demand
• Price Elasticity of Demand: A measure of the
relationship between a change in the quantity demanded
of a particular good and a change in its price.
• Cross Elasticity of Demand: It measures the
responsiveness of the quantity demanded for a good to
a change in the price of another good, ceteris paribus.
8. Types of Elasticity of Demand(cntd..)
• Income Elasticity of Demand: It measures the
responsiveness of the quantity demanded for a good
or service to a change in the income of the people
demanding the good, ceteris paribus.
9. Price Elasticity of Demand
The price elasticity of demand (PED) is a measure that
captures the responsiveness of a good's quantity demanded to
a change in its price. More specifically, it is the percentage
change in quantity demanded in response to a one percent
change in price when all other determinants of demand are
held constant.
FORMULA:
PED = %Change in Quantity Demanded / %Change in Price
10. DEGREES OF PRICE ELASTICITY OF
DEMAND
1. Perfectly Elastic Demand:
11. DEGREES OF PRICE ELASTICITY OF
DEMAND(cntd...)
2. Perfectly Inelastic
Demand:
3. Unitary Elastic Demand:
12. DEGREES OF PRICE ELASTICITY OF
DEMAND(cntd...)
4. Relatively Elastic
Demand:
5. Relatively Inelastic Demand:
13. FACTORS AFFECTING PRICE
ELASTICITY OF DEMAND
• Nature of commodity
• Availability of substitutes
• Income level
• Level of price
• Postponement of consumption
• Number of uses
• Share in total expenditure
• Time period
• Habits
14. Income Elasticity of Demand
Types Of Income Elasticity Of Demand:
Positive Income elasticity of demand
P
A
Y
D
D
B SO
X
Quantity Demanded
Income
15. Income Elasticity of Demand(cntd…)
Negative Income Elasticity of Demand
Price
P
B
A
S
Total Revenue
Quantity Demanded
(000s)
16. Income Elasticity of Demand(cntd…)
Zero Income Elasticity of Demand
X
Y
O D
D
Quantity Demanded
Income
Y’’
Y’
Y
18. Methods of Calculating Elasticity of Demand
• Ratio (or Percentage) Method
The most popular method used to measure elasticity.
Elasticity of demand is expressed as the ratio of proportionate change
in quantity demanded and proportionate change in the price of the
commodity.
It allows comparison of changes in two qualitatively different
variables.
It helps in deciding how big a change in price or quantity is.
where Q1= original quantity demanded, Q2= new quantity demanded,
P1= original price level, P2= new price level
XcommodityofpriceinchangeateProportion
XcommodityofdemandedquantityinchangeateProportion
=ep
19. Methods of Calculating Elasticity of Demand
• Point Elasticity Method
– Elasticity measured at a point of demand curve is
referred as point elasticity of demand.
• For nonlinear demand curve we need to apply calculus to
calculate point elasticity.
• As changes in price become smaller and approach zero, the
ratio becomes equivalent to the first order derivative of the
demand function with respect to price
• Point elasticity can be expressed as:
ep = =
PdP
QdQ
/
/
dP
dQ
Q
P
.
20. Methods of Calculating Elasticity of Demand
• Arc Elasticity Method
– Used when the available figures on price and quantity are
discrete, and it is possible to isolate and calculate the
incremental changes.
– It is used to find the elasticity at the midpoint of an arc
between any two points on a demand curve, by taking the
average of the prices and quantities.
– This method finds wider applications, as it reflects a
movement along a portion (arc) of a demand curve
ep = /
=
2/)( 21
12
QQ
QQ
+
−
2/)( 21
12
PP
PP
+
−
12
21
PP
PP
−
+
21
12
QQ
QQ
+
−
21. Methods of Calculating Elasticity of Demand
• Total Outlay Method (Marshall)
– Elasticity is measured by comparing expenditure levels before and after
any change in price, i.e. whether the new expenditure is more than, or
less than, or equal to the initial expenditure level.
– Helps a seller in taking a decision to raise price only if:
• Reduction in quantity demanded does not reduce total revenue or
• Reduction in price increases the quantity demanded to the extent
that total revenue also increases.
– Degrees
• When demand is elastic, a decrease in price will result in an
increase in the revenue (sales).
• When demand is inelastic, a decrease in price will result in a
decrease in the revenue (sales).
• When demand is unit-elastic, an increase (or a decrease) in price
will not change the revenue (sales)
22. Factors Affecting Elasticity of Demand
• Availability of substitutes
• Nature of product
• Share in total expenditure
• Postponement of consumption
• Number of uses
• Time period
• Income level of consumer
23. Uses of Elasticity of Demand
• Decision of Monopolist
• The Government
• Business Sector
• Input Price
• Rate of Exchange and Balance Payment
24. Case Study:
• The health club market provides an interesting case
study in using the concepts of price elasticity of
demand and income elasticity of demand.
• Regular gym users regard their health club visits as
an important feature of their weekly exercise regime.
They are unlikely to cancel a membership if fees rise
from time to time. And, for most consumers, having
made the decision to commit themselves to a
membership of between $25-$50 per month, a small
rise in fees is unlikely to lead to a cancelled
membership.
25. Case Study(cntd…):
• Normal luxury products have a highly positive
income elasticity of demand. When the economy is
strong, and incomes and employment are rising, we
expect to see strong growth in market demand for
health and fitness activities. This encompasses health
clubs together with other activities (including sports-
based holidays).
• In an economic slowdown, discretionary spending on
health clubs may fall-although in the short term,
thousands of members are committed to an annual
fee.
