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Elasticity measures
What are they? Why introduce them?
Responsiveness measures
Demand and supply responsiveness clearly matters for lots of market analyses. Want to compare across markets: inter market Want to compare within markets: intra market slope can be misleading want a unit free measure
What is an Elasticity?
Measurement of the percentage change in one variable that results from a 1% change in another variable.
- These variables are price of the commodity, prices of the related commodities, income of the consumer & other various factors on which demand depends. Thus, we have i. Price Elasticity, ii. Income Elasticity, iii. Cross Elasticity, iv. Arc Elasticity. It is always price elasticity of demand which is referred to as elasticity of demand
Rabin Mazumder; Faculty of Economics
Price elasticity of demand: Keeping other things constant it is the percentage change in quantity demanded due to a percentage change in the price.
% change in quantity demanded price elasticity of demand % change in price Mathematically: P = Current price of good X Q = Quantity demanded at that price P = Small change in the current price Q= Resulting change in quantity demanded ep= Price elasticity of demand Q/Q -ve sign indicates that there is an inverse ep = (-) P/P relationship between price & quantity demanded
Elastic Demand
When quantity demanded responds more than the price changes then it is called elastic demand Here, ep>1 P Luxurious commodity
P0 P1
A B
Q0
Q1
Inelastic Demand
When quantity demanded responds less than the price changes then it is called inelastic demand.
Here, ep P Necessary commodities
P0 P1
<1
Q0 Q1
=1
Elasticity = 1
Necessary commodities
0
Rabin Mazumder; Faculty of Economics
Super Luxurious
Perfectly Elastic Demand (elasticity = )
Po
Commodities
Qo
Q1
Quantity
P1
Perfectly Inelastic Demand (elasticity = 0)
Po
Qo
Quantity
When the income elasticity of demand is positive (normal good), consumers increase their purchases of the good as their incomes rise (e.g. automobiles, clothing). When the income elasticity of demand is greater than 1 (luxury good), consumers increase their purchases of the good more than proportionate to the income increase (e.g. Diamond). When the income elasticity of demand is negative (inferior good), consumers reduce their purchases of the good as their incomes rise (e.g. potatoes).
Income elasticity
Types: Zero Negative Positive (i) low (ii) unitary (iii) high Income elasticity and business decisions 1. If ei is >0 but <1, sales will increase but slower than the general economic growth; 2. If ei is >1, sales will increase more rapidly than general economic growth 3. Corollary: in a growing economy while farmers suffer as their products have low income elasticity, industrialists gain as their products have high income elasticity.
Rabin Mazumder; Faculty of Economics
cross-price elasticity for complementary good is negative because as the price of a complementary good rises, the quantity demanded of the good itself falls. Example : software is complementary with computers. When the price of software rises the quantity demanded of computers falls. cross-price elasticity for substitute good is positive because as the price of a substitute good rises, the quantity demanded of the good itself rises. Example : hockey is substitute for basketball. When the price of hockey tickets rises the quantity demanded of basketball tickets rises.
Rabin Mazumder; Faculty of Economics
The demand curve for good X shifts with changes in the price of good Y
P
1.
Percentage or Proportionate Method = Percentage change in demand Percentage change in price or; = Proportionate change in demand Proportionate change in price
2. Total Outlay (Expenditure) Methods TO=TQ* P ; where, TO=total outlay; TQ=total quantity; P=price of the commodity 3. Geometric (Point) method at any given point on the curve = lower segment of demand curve Rabin Mazumder; Faculty of upper segment of demand curve Economics
If the price elasticity of demand = 1, then a reduction in price will increase demand in proportion and TR will be unchanged If the price elasticity of demand is < 1, then a reduction of price will increase demand less than proportionately and TR will fall.
Rabin Mazumder; Faculty of Economics
0 TR
Q Max TR
TR rising
0
TR falling
Q
quantity
Q increases Total revenue increases Q decreases Total revenue decreases Q increases Total revenue decreases Q decreases Total revenue increases Q increases Total revenue unchanged Q decreases Total revenue unchanged
Inelastic
Unitary elastic