According
to Alfred Marshall in his famous book, ‘Principles of Economics’, while
introducing the concept of the elasticity of demand, “The elasticity of demand
in a market is great or small according to whether the amount demanded
increases much or little for a given fall in price, and diminishes much or
little for a given rise in price.”
(i)
Availability of Substitutes : One of the most important determinants of price elasticity of
demand for a commodity is the availability of its substitute. The closer the
substitute, the greater the elasticity of demand for a commodity.
(ii)
Nature of Commodity : Price elasticity of demand depends also on the nature of a
commodity. Commodities can be grouped broadly as luxuries, comforts and necessities,
on the basis of their nature.
(iii)
Proportion of Income Spent : Another factor that influences the elasticity of demand is the
proportion of income which the consumers spend on a particular commodity. If
the proportion of income spent on a commodity is very small, its demand will be
inelastic, and vice-versa.
(i)
Perfectly Elastic Demand : Demand for a commodity is said to be perfectly elastic when the
demand for it may increase or decrease to any extent irrespective of any change
or infinite change in its price.
(ii)
More than Unit Elastic Demand : Demand for a commodity will be said to be elastic if a change in
price results in a significant change in demand for this commodity.
(i)
For Finance Minister : The finance minister imposes taxes on those whose demand is
price-insecure so that tax revenues increase. Similarly, on indirect taxes, the
finance minister imposes a tax on the items which have a continuous demand
among the rich section and thus the burden of taxes is levied on the rich
class.
(ii)
For Taking Over Public Utility Services : State takeing over of public utility services can also be
explained with the help of elasticity of demand. Demand for public utilities
such as electricity and water supply, posts and telegraphs, public
transportation, etc., is generally inelastic in nature. If operation of such
public utilities is entrusted to private individuals, they are likely to
exploit the consumer. Therefore, in the interest of social welfare, the
government owns and runs such services.
It
can be concluded from the above findings that demand of the same slope curves
may vary, and the demand for different slope curves can be similar at a fixed
price.
Question
11. Suppose demand schedule is given as follows:
|
Price (in ₹) |
100 |
80 |
60 |
40 |
20 |
0 |
|
Quantity |
100 |
200 |
300 |
400 |
500 |
600 |
(i)
Availability of Substitutions : The closer the substitute, the elasticity of demand for one
commodity is higher. For example, coffee and tea can be considered alternatives
to each other. If price of one of these goods increases, then the other
commodity becomes relatively cheaper. Therefore, consumers buy more of the
relatively cheaper goods and less-of the costlier one. The demand elasticity
for both items will be high. Besides, the wider the range of the substitutes,
the greater the elasticity.
(ii)
Time Factor : Price-elasticity
of demand also depends on the time that consumers take to adjust to a new
price, when the long-term elasticity is high. For this, consumers are able to
adjust their expenditure patterns for price changes over a period of time. For
instance, if price of TV sets is decreased, demand will not immediately
increase unless people possess excess purchasing power. But over time, people
may be able to adjust their expenditure pattern so that they can buy a TV set
at the (new) lower price.
Above
given diagrammatic representation is of perfectly inelastic demand. Here, the
demand curve DD is parallel to OY-axis. If the price is ₹ 2, demand is for 4
units. When price increases from ₹ 4 to ₹ 6, the demand remains the same i.e.,
4 units. Thus, change in price does not show any effect on demand. In this
situation, elasticity of demand (Ed) is zero or Ed =
0.
Very Short Answer Type Questions
Question
9. What will be’ the elasticity of demand when:
|
Price (in ₹) |
Quantity Demanded (Units) |
Total Expenditure (in X) |
|
6 |
5 |
30 |
|
5 |
6 |
30 |
Answer:
Elasticity of demand is equal to unity. Because, in response to a change in
price, total expenditure has not changed even when quantity demanded has
increased.
Long Answer Type Questions
(ii)
Availability of Substitutes : Demand for those commodities which have a substitute (for
example, tea has its substitute in coffee, orange juice has its substitute in
lime juice) are relatively more elastic.
(iii)
Different Uses of Commodity : Commodities that can be put to a variety of uses have elastic
demand. For instance, electricity has multiple uses. It is used for lighting,
room-heating, air-conditioning, cooking, etc. If the tariffs of electricity
increase, its use will be restricted to important purposes like lighting. It
will be withdrawn from less important uses. On the other hand, if a commodity
such as paper has only a few uses, its demand is likely to be inelastic.
(iv)
Income of Consumer : People whose incomes are very high or very low, their demand
will ordinarily be inelastic. Because rise or fall in price will have little
effect on their demand. Conversely, middle income groups will have elastic
demand.
(v)
Habit of Consumer : Goods to which a person becomes accustomed or habitual will have
inelastic demand like cigareette, coffee, tobacco, etc. It is so, because a
person cannot do without them.
The
diagram represents that the demand is perfectly inelastic. A curve DD is
parallel to axis-OY. If price is ₹ 2, then demand is 4 units. When price
increases to ₹ 4, the demand remains stable, i.e., ₹ 4 units. Therefore, no
change occurs in demand, if the price increases. Elasticity of demand is equal
to 0.
A
curve DD which is parallel to OX-axis is a perfectly elastic demand curve. It
represents that when the price of commodity slightly rises from ₹ 4, the demand
of the commodity will fall to 0. At the current price of ₹ 4, the consumer can
buy 10 or 20 or 30 units or any quantity that he wants. In this situation,
elasticity of demand is uncertain, means infinite or Ed = (∞).
According
to Alfred Marshall in his famous book, ‘Principles of Economics’, while
introducing the concept of the elasticity of demand, says; “The elasticity of
demand in a market is great or small according to whehter the amount demanded
increases much or little for a given fall in price, and diminishes much or
little for a given rise in price.”
(i)
Total Expenditure or Total Outlay Method : In this method, we measure the effect of change in price on
total expenditure. We can presume three possible conditions:
- When
the price, change (price increase or decrease) does not show the impact on
total expenditure, it is called the Position of Unitary Elastic Demand.
- When
the price change shows the impact on total expenditure. If because of rise
in price, total expenditure decreases and if fall in price shows total
expenditure increase, it is known as Greater than Unitary Elastic Demand.
- When
the price change shows the impact on total expenditure. If because of rise
in price, total expenditure increases and a fall in price shows total
expenditure decrease, it is known as less than Unitary Elastic Demand.
This
graphical representation shows that axis-OY shows price and the axis-OX shows
total expenditure curve. TE is the curve of total expenditure. Curve BC
represents unitary elastic demand. It represents that if price is OM, then
total expenditure is MC, when price increases to ON, then total expenditure
remains constant.
Here,
NB = MC
TB
curve shows greater than unitary elastic demand. It represents that if there is
rise in prices from ON to OR, total expenditure decreases from NB to RA. Curve
EC shows less than unitary elasticity of demand. It represents that when the
price reduces from OM to OP then the total expenditure also decreases from MC
to PO.
(ii)
For Monopolist : The
price elasticity concept is very important, particularly to a monopolist who
decides his own prices for goods. If the demand for their goods is inelastic,
it would be beneficial to charge it at a higher price and sell a slightly
smaller volume. If demand is elastic, it will be beneficial to charge a lower
price and increase the sales volume.
(iii)
For Finance Minister : Whenever the finance minister considers raising the rates of tax
on existing tax items in view of the introduction of fresh levy on some items
or for getting more revenue for the state, he conducts a thorough study of the
elasticity of demand for commodity. The finance minister often taxes those
items less whose demand is price-elastic. This leads to an increase in the
taxation revenue from indirect taxes. In contrast, the finance minister taxes
those items highly which are constantly demanded by the rich class and the burden
of taxation is laid more on the rich class.
(iv)
For Determination of Prices of Joint Products : The concept of elasticity of demand is used
in the value of combined products, such as cotton and cotton seeds, wool and
mutton, wheat and straw etc. It is not possible to find individual marginal
costs of combined products here. During price fixing, producers are mostly
directed by elasticity of demand. But its total receipts must cover the total
cost. Transport authorities have decided to fix their rates according to the
principle that ‘what will be the traffic’.
(v)
For Explaining the Paradox of Poverty in the Midst of Plenty: The concept of elasticity
of demand suitably explains the parodox of poverty in the midst of plenty. For
example, if there is a bumper crop of wheat, then it can give farmers a signal
of calamity rather than prosperity, if the demand for wheat is incompatible.
Due to the increase in supply, the decline in the price of wheat will reduce
the income of the farmers.
(vi)
For Determining Reward of Factors of Production : The elasticity of demand is equally
important in determining the awards of various factors of production in the
country. For example, if demand for workers is elastic, trade unions’ efforts
to meet the wages of workers will be met with failure. On the contrary, if
demand for labour in a particular area is real, then trade unions can get more
wages from the employer. This is also true about other factors of production.
The factors of production that have more elastic demand, they accept small
prizes; and the factors having an inelastic demand can be provided a big
reward.
(vii)
For Taking Over Public Utility Services : The state’s decision can also be explained with the help of the
elasticity of demand for acquisition of public utility services. Demand for
public utilities such as electricity and water supply, posts and telegraphs,
public transport, etc. is generally inelastic in nature. If such public utility
is assigned to private iiidividuals, then they are likely to exploit the
consumer. Therefore, in the interest of social welfare, the government is the
owner of such services and runs these services. For example, in Bombay City,
the bus service was operating privately in the suburban areas. It was later
acquired by the Greater Bombay Municipal Corporation.
(viii)
For Pricing Policy for Public Utilities : Price elasticity is also influential in determining the price
policy of public utility undertakings, like electric supply undertakings,
railways, etc. Such undertakings determine their rates for different uses on
the basis of the elasticity of demand and try to cover the losses from one
group of users out of the gains reaped from the other group.
(ix)
Terms of Trade Between Two Countries : In international trade, the price elasticity of demand is
helpful in ascertaining the ‘terms of trade’. If exports have inelastic demand,
a higher price can be charged from abroad. Similarly, if imported goods have
elastic demand in the domestic market, a lower price is to be fixed. Both these
enable a country to have favourable ‘terms of trade’ in respect of
international trade.
(x)
Determination of Rates of Foreign Exchange : In order to determine the foreign exchange
rates for domestic currency, the government must keep in mind the elasticity of
demand for its exports and imports. This will help the government to know the
potential effects of devaluation or re-evaluation of its currency with respect
to foreign currencies. If the government devalues the currency without
carefully studying the elasticity of demand and demand for the country’s
exports, then it cannot be successful in achieving its goal.
(xi)
For Price Control Policy : In undeveloped countries like India, the price control policy
can be adopted only after assessing the value of strategic goods demand. In
terms of low-level items with elasticity or redundant demand, price control is
usually used.
(xii)
For Tariff Policy : Imposition of tariff raises the prices of domestic goods. The
extent to which the internal price rises, depends on the elasticity of demand
of the protected goods. If the demand for the protected goods is elastic, their
sales will be reduced with the rise in prices. On the contrary, if the demand
is less elastic, people will have to bear the burden of higher prices as a
result of the tariff policy.
(xiii)
Incidence of Taxation : Incidence of tax lies on the person who ultimately pays the
tax. The incidence is on the buyer. If demand is perfectly inelastic, he will
go on buying, as much as before, despite the price rise. The government has to
keep in mind the ultimate burden of the tax, which depends on the elasticity of
demand of the commodity taxed. If necessities, which have less elastic demand,
are taxed, the burden will fall more on the poor section of society.
(ii)
Arc Elasticity of Demand : When price-elasticity of demand is measured between any two
finite points on a demand curve, it is called Arc Elasticity.
A
curve DD which is parallel to OX-axis is a perfectly elastic demand curve. It
represents that when the price of commodity slightly rise from ₹ 4, the demand
of the commodity will fall to 0. At the current price of ₹ 4, the consumer can
buy 10 or 20 or 30 units or any quantity that he wants. In this situation,
elasticity of demand is uncertain, means infinite or Ed = (∞).
Figure
shows less than unitary elastic demand (Ed < 1)
This
figure represents, when price is OP, then quantity demanded is OB, sum total
expenditure = OB*OP = OBTP (area). Similarly, when price is OPj and the
quantity demanded is OC, then total expenditure = OCRP1 (area). It is clear
that area of OBTP is greater than area of OCRP1 It indicates that total
expenditure is decreased in the reaction to fall in price of the commodity.
Therefore, elasticity of demand is lesser than a unit, (Ed <
1).
Figure
shows greater than unitary elastic demand
Figure
shows the perfectly inelastic demand
The
diagram represents that the demand is perfectly inelastic. A curve DD is
parallel to axis-0Y. If price is ₹ 2, then demand is 4 units. When price
increases to ₹ 4, the demand remains stable, i.e., ₹ 4 units. Therefore, there
is no change in demanded quantity if the price increases, hence, elasticiy of
demand is equal to 0.
(ii) Proportionate or Percentage Method : Proportionate or percentage method is proposed by Marshall. Elasticity of demand is measured by the ratio of the proportionate change in quantity demanded to the proportionate change in price.
(iii) Geometric Method : It is the method through which elasticity of demand is measured at differents point of the curve. It is also known as ‘Point Method.’
(i)
Availability of Substitutes : The most significant determinant of price elasticity of demand
for a commodity is the availability of its alternatives. The elasticity of
demand for a commodity increases as much as it is close to the alternative. For
example, coffee and tea can be considered as a close alternative to each,
other, if the price of one of these goods rises, then the second commodity
becomes relatively cheaper. Therefore, consumers buy cheaper and less expensive
goods.
(ii)
Nature of Commodity : The price elasticity of demand depends on the nature of a
commodity. Commodities can be broadly divided on the basis of their nature as
luxury, comforts and requirements. Luxury goods’ demand is more elastic than
the demand for other types of goods because consumption of luxury goods can be
postponed when their price rises. On the other hand, consumption of essential
goods cannot be postponed and hence their demand is inelastic. Demand for
durable goods is more elastic than that for non-durable goods, because when the
price of the former increases, people either get the old one repaired instead
of replacing it or buy a ‘second hand’ product.
(iii)
Proportion of Income spent: Another factor affecting the elasticity of demand is the
proportion of income which consumers spend on a particular commodity. If
proportion of income spent on a commodity is very small, then its demand will
be inelastic, and vice-versa. The classic examples of such commodities are
salt, matches, books, toothpastes, etc., which claim a very small proportion of
consumers’ income. Demand for these goods is generally inelastic because
increase in the price of such goods does not substantially affect the
consumer’s budget, and hence its demand.
(iv)
Time Factor : The
price elasticity of demand also depends on how much time consumers take to
adjust to a new price. The more time it takes, the more elastic the demand will
be. is. For, consumers are able to adjust their expenditure pattern to price
changes over a period of time. For example, if price of TV sets is decreased, demand
will not immediately increase unless people possess excess purchasing power.
But over time, people may be able to adjust their expenditure pattern so that
they can buy a TV set at the new lower price.
(v)
Range of Alternative Uses of a Commodity : The wider the range of alternative uses of a product, the
higher the elasticity of its demand. Decreases in the price of a multi-use
commodity encourages the extension of their use. Therefore, the demand : for
such a commodity generally increases more than the proportionate decrease in
its price. For instance, milk can be taken as it is, it can be converted into
curd, cheese, ghee and butter milk. The demand for milk, will therefore be
highly elastic. Similarly, electricity can be used for lighting, cooking, heating
and for industrial purposes, therefore, demand for electricity is elastic,
especially, for decrease in price.
(vi)
The Proportion of Market Supplied : The elasticity of market demand depends also on the proportion
of the market supplied at the ruling price. If less than half of the market is
supplied, elasticity of demand will be higher and if more than half of the
market is supplied, elasticity will be lower. That is, towards the upper end,
demand curve is more elastic than towards the lower end.
(vii)
Direction of Change in Price : The direction of change in price also determines the
elasticity. Between any two finite points on the demand curve, elasticity is
higher for the fall in price and vice-versa.
Numerical Questions
Elasticity
of demand = 4 (Greater than unity)
Solution : Suppose, the consumer will purchase Q1 units of the commodity.
Multiple-Choice Questions
Question 18. Price elasticity of demand can be measured by using :
Question 22. Match the effects of rise in price on consumer expenditure and elasticities of demand :
Question 29. Formula for elasticity of demand by geometric method :
Question 31. The elasticity of demand at point P in point method will be :
