Livestock Economics, Marketing and Business Management

ELASTICITY OF DEMAND

Defination

• Elasticity of demand is defined as proportionate change in quantity demanded in response to proportionate change in price.

Price elasticity of demand

• It is defined as relative responsiveness of quantity demanded of a commodity to the percentage change in its price.

Measurement of price elasticity

• Elasticity of demand can be measured by three methods viz.
  • Proportional method
  • Total outlay method and
  • Geometrical method

Proportional method

• In proportional method, price elasticity of demand is measured as below.
• Price elasticity of demand is the ratio of proportionate change in the quantity demanded to the proportionate change in the price.

• Suppose price of an egg falls from Rs. 1.25 to Re.1 and as a result, the demand rises from 10 to 15 eggs, then price elasticity of demand (Ep)

• This indicates that for one- percent decreases in price, there would be 2.5 per cent increase in the quantity demanded.

Total outlay method

• In total outlay method, from the changes in the total expenditure made on a good as a result of changes in its price, the price elasticity of demand for the good is measured.
• But with this method, we can know only whether the elasticity is equal to one, greater than one or lesser than one and we cannot precisely work out the coefficient of elasticity.
• If the total expenditure made on the good remains the same, when the price of a commodity consumed changes, the elasticity of demand is equal to one.
• Because, the total expenditure made on the good can remain the same, only when the proportional change in the quantity demanded is equal to the proportional change in price.
• When the total expenditure made on the good increases as a result of a fall in price or when the total expenditure decreases as a result of a rise in price, then the price elasticity of demand will be greater than one.
• When the total expenditure decreases as a result of a fall in price or when the total expenditure increases as a result of a rise in price, then the price elasticity of demand will be less than one.
• Consider the following table, which gives quantity demanded of milk at various prices.

Total outlay and elasticity of demand

• Quantity demanded increases from 50 litres to 60 litres and total outlay increases from Rs. 725 to Rs. 855, when the price decreases from Rs. 4.50 to Rs. 4.25 i.e. the quantity demanded increases so much that the total outlay on milk increases indicating thereby that elasticity of demand is greater than one at these prices.

Price of milk (Rs.) per litre	Quantity demanded in litres	Total outlay (Rs.)	Elasticity of demand
14.50	50	725.00	-
14.25	60	855.00	e>1
14.00	75	1050.00	e>1
13.75	80	1100.00	e=1
13.50	84	1134.00	e<1
13.25	87	1152.75	e<1

• When the price falls from Rs. 4.00 to Rs. 3.75, the quantity demanded increases from 75 to 80 litres so that total outlay remains the same at Rs. 300.
• This shows that price elasticity of demand is unity. When the price of milk further falls from Rs. 3.75 to Rs. 3.50 and then to Rs. 3.25, total outlay spent on milk decreases in spite of the increase in the quantity demanded.
• Thus, the elasticity of demand for milk at these prices is less than unity.

Geometrical method

• Geometrical method tells how to measure elasticity of demand at any point on a curve.
• Following is the straight demand curve DD'. Elasticity at a particular point is represented by a fraction -distance from D' to that point divided by the distance from the other end.
• Thus elasticities of demand on the points P, Q, and R are D' P/DP, D' Q/DQ and D' R/DR respectively. Since Q is in the middle of the curve, elasticity D' Q/DQ is equal to one.
• Any point above this point will have an elasticity of more than one and points below Q will have elasticity of less than unity. Therefore, it can be concluded that elasticity of demand is different at different points of the same curve.
• Elasticity calculated in this way can be called as point elasticity. (Click here to view graph)
• Point elasticity can be used only when the demand curve is known. However, often only scanty data on price and quantity are available in which cases it will be difficult to find point elasticity.
• Instead, we shall have arc elasticity (an arc is a portion or a segment of a curve).
• Instead of using old and new price and quantity, here we take the average of both. Thus the arc elasticity is the average elasticity which is equal to

Income elasticity of demand

• It is the responsiveness of change in quantity purchased to change in income.
• Luxury goods will have high-income elasticity while the necessaries have low-income elasticity of demand.

Cross elasticity of demand

• It is a measure of responsiveness of demand for goods to given change in the price of related goods.