ECONOMIC ANALYSIS

Module 2. Theory of demand

Lesson 10
ELASTICITY OF DEMAND – MEANING, PRICE ELASTICITY

10.1 Introduction

This lesson describes the concept of elasticity of demand. According to the law of demand, demand increases with decrease in price and vice versa, other things remaining same. According to the law, demand changes with price. But this change is not same in all circumstances. In some instances change is very wide & in some it is very small. This variation indicates the responsiveness of demand with change in price. Economists use the term elasticity to measure this responsiveness.

10.2 Elasticity of Demand

Elasticity of demand is ratio of two variables as given below.

The three important types of elasticity of demand are

(i) Price elasticity (ii) Income elasticity (iii) Cross elasticity

10.3 Price Elasticity of Demand

This indicates the response of demand with respect to change in price, other factors remaining constant, mathematically it is indicated by

By using any of the above formula, it is possible to measure & know values of co-efficient of price elasticity which varies from zero to infinity. Through this producer can know how much demand of its product will be affected by a change in its price.

10.4 Classification of Price Elasticity

Based upon extent of responsiveness of demand with change in price, price elasticity is further categorized into following five types.

I) Perfectly Elastic Demand: According to this concept, demand & Price are so much related that at a particular given price demand is endless but if even a very small price rise is noticed then buyers stops purchasing the commodity. The numerical co-efficient of perfectly elastic demand is infinity (e = α). Graphically at can be indicated as in Fig 10.1.

Figure 10.1 shows that at given price OP, the consumer will be purchasing infinite quantity and with an even slight increase in price beyond OP, Consumer will stop buying. Actually this is a theoretical concept. In actual practice one cannot find such consumer behaviour.

II) Perfectly inelastic Demand: This is another theoretical concept which highlight that demand remain same irrespective of price change. Its numerical co-efficient value is zero. Graphically the concept can be represented as given in Fig 10.2.

The Figure 10.2 shows that the demand DD remains same irrespective of price rise from P₁ to P₂ to P₃.

III) Unitary Elastic Demand: When the percentage change in quantity demanded is exactly the same as percentage change in price, the demand is called unitary elastic whose numerical value is 1. Graphically it can be represented as shown in Fig 10.3.

Figure 10.3, indicates that when price increases from P1 to P2 the demand decreases from M2 to M1 exactly in the same proportion.

IV) Relatively Elastic Demand: Under this concept, the Proportion change in price whose numerical value is in between 1 and infinity. Graphically it can be represent as shown in figure in Fig 10.4.

Figure 10.4 clearly indicates that the as price decreases from P2 to P1, relatively higher proportional change is visible in quantity demanded from M2 to M1.

V) Relatively Inelastic Demand: Under this concept, the proportion change in quantity demanded is relatively less as compared to corresponding proportion change in price. The numerical value of relatively inelastic demand lies between zero and one. Its graphical representation is shown in Fig 10.5.

Figure 10.5 indicates that when price changes decreases P2 to P1, the relative increase in quantity demanded is less as seen from M2 to M1