1. Elasticity and Its Measurement
Concept of Demand and Demand Function
Demand
Demand is defined as the effective desire for a good or service backed by ability and willingness to pay. It is also defined as the quantity of a good or a service which a consumer would buy in a market at a given price and time period.
Demand Function
The demand for a particular commodity is influenced by so many factors-they together are known as determinants of demand in technical jargon, it is stated as demand function. A demand function in mathematical term expresses functional relationship between the demand for a product and its various determining factors. For instance,
Qdx = f(Px, Py,Y, Adv, T&P, F, Cl, Pop., Gov.Pol,……….)---------Multivariate demand FunctionTypes of Demand Function
1] Short Run Demand Function: Qdx = f(Px)------OTRS
2] Long Run Demand Function: Qdx = f(Px, Py, Y, Adv, T&P, F, Cl, Pop., Gov.Pol,….)
3] Linear Demand Function: The slope of the demand curve remains constant throughout its length is known as LDF. In other words, if both independent and dependent variable changes at a constant rate, the demand function will be linear.
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| Linear Demand Function |
Qdx = α - β ⇒ Px = 80 - 4Px
Slope of A to B =ΔP/ΔQ
= (P2 - P1)/(Q2 - Q1 ) = (5-0)/(60-80) = -5/20 = -1/4
Slope of B to C = ΔP/ΔQ
= (P2 - P1)/(Q2 - Q1 ) = (10-5)/(40-60) = -5/20 = -1/4
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| Linear Demand Curve |
It is a straight-line curve with constant ΔQ/ΔP i.e. change in demand w.r.t. change in price is same on the whole curve. It creates the demand line.
4] Non-linear Demand Function: A demand function is said to be non-linear when the slope of a demand curve changes all along the demand curve. If both dependent and independent variable generally expressed in power function as follows:
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| Non Linear Demand Function |
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| Non Linear Demand Curve |
It is curvi-linear shaped with ΔQ/ΔP changes along the demand curve. It creates the demand curve.
Concept of Supply and Supply Function
Supply
Supply is the quantity of goods and services that a producer is willing and able to produce for market transaction at a give price in a give time period. The price of a product impacts the supply of the product and vice versa. The rise in the market price of a product enables producers to produce more. Hence, the rise in price means an increment in the supply. The rise in price and rise in supply is directly proportional to each other. The law of supply states that there is positive relationship between price level and quantity supply i.e. Qsx = α + βPxSupply Function
The supply for a particular commodity is influenced by so many factors-they together are known as determinants of supply in technical jargon, it is stated as supply function. A supply function in mathematical term expresses functional relationship between the supply for a product and its various determining factors. For instance,
Qsx = f(Px, Fp, Tech., Cl, GP., No. of Seller, Expect ……….)----------Multivariate Supply FunctionTypes of Supply Function
1] Short Run Supply Function: Qsx = f(Px) ------ OTRS
2] Long Run Supply Function: Qsx = f(Px, Fp, Tech., Cl, GP., No. of Seller, Expect., ……….)
3] Linear Supply Function: The slope of the supply curve remains constant throughout its length is known as LSF. In other words, if both independent and dependent variable changes at a constant rate, the supply function will be linear.
Qsx = α + βPx = 10 + 5Px |
| Linear Supply Function |
Slope of b to c =ΔP/ΔQ=(P2-P1)/(Q2-Q1 )=(3-2)/(25-20)=1/5
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| Linear Supply Curve |
It is a straight line curve with constant ΔQ/ΔP i.e. change in supply w.r.t. change in price is same on the whole curve. It creates the supply line.
4] Non-linear Supply Function: A supply function is said to be non-linear when the slope of a supply curve changes all along the supply curve. If both dependent and independent variable generally expressed in power function as follows:
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| Non Linear Supply Function |
Slope of a to b =ΔP/ΔQ=(P_2-P_1)/(Q_2-Q_1 )=(10-5)/(300-150)=5/150=1/30
Slope of b to c =ΔP/ΔQ=(P_2-P_1)/(Q_2-Q_1 )=(15-10)/(550-300)=5/250=1/50
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| Non Linear Supply Curve |
Concept & Types of Elasticity Demand
Concept of ED
Elasticity of demand refers to the degree of responsiveness in demand for a commodity to the change in any of its determinants. In other words %Δ in Qdx divided by the %Δ in its determinants. First introduced by classical economist A. A. Cournot & J. S. Mill and later on Neo-classical economist, Alfred Marshall developed it in the scientific way in his book "Principle of Economics" published in 1890 A.D.
Symbolically, Ed = %Δ in Qd / %Δ in its determinantsPrice Elasticity of Demand (PED)
Ep means how strongly do consumer react (by using less) if you raise your product price. So, Ep is the reaction of quantity on price.Symbolically,
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| Price Elasticity of Demand |
Degrees/Types of PED
1] Perfectly Elastic Demand
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| Perfectly Elastic Price Elasticity of Demand |
2] Perfectly Inelastic Demand
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| Perfectly Inelastic Price Elasticity of Demand |
3] Unitary Elastic Demand
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| Unitary Elastic Price Elasticity of Demand |
4 ] Relatively Elastic Demand
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| Relatively Elastic Price Elasticity of Demand |
5] Relatively Inelastic Demand
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| Relatively Inelastic Price Elasticity of Demand |
Table Example of Price Elasticity of Demand
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| Table: Types of Price Elasticity of Demand |
Determinants of PED
1] Availability of Substitutes
If available →User switches product → More elasticIf not →User can't switches product → Inelastic
2] Time Period
Longer time horizon → Choice → More elastic & Vice-versa [Postponement condition]3] Nature of Goods
Necessary → Inelastic, Luxury → Elastic & Habit forming goods (cigarette) → Inelastic4] Proportion of Income Spent
Greater proportion → Elastic & Small proportion → Less elastic5] Number of Uses of a Commodity
Multiple use (electricity) → Elastic & Single use (Ink) → Less elastic6] Price Expectation of Buyers
Price fall expectation → Less responsive demand & vice – versaUses or Importance of PED
Ep has great practical importance in the formulation of economic policies & understanding economic problems. Manager should able to answer:
- How much do we have to cut our price to achieve 3% sales growth?
- If we cut price by 5%, how many more units will be sold?
1] Helpful to monopolist in fixing price
More elastic → Profit increase by lowering price
Less elastic → Profit can increase by increasing price
2] Helpful to the government in formulating taxation policies
The finance minister has to consider the nature of Ed for a commodity before levying an excise tax on it.
Inelastic demand → Tax↑ → Public revenue↑
Necessary goods → Tax↓ & Luxurious goods → Tax↑
3] Wage determination
Inelastic demand for labor → Trade union can force the employer to increase the wage organizing strike
Elastic demand for labor → Union tactics can't work to raise wage
3] International Trade
Export commodity has inelastic demand and Import commodity has elastic demand → beneficial to the nation
4] Helpful in determining the rate of exchange
Before deciding to devalue or revalue domestic currency in relation to foreign countries, the government has to study carefully the elasticities of demand for its imports and exports.
5] Helpful in declaring certain industries as 'Public Utilities'
The concept of Ed also enables the government to decide as to what particular industries should be declared as public utilities and being consequently owned & operated by state.
6] Price determination of public utilities like postal office, drinking water, electricity etc.
Inelastic demand → Price↑ & Elastic demand → Price↓
7] Price determination of joint products like sheep & wool, paddy & straw -wfg / k/fn_
Cost of production cannot be calculated separately. So Ed is useful to determine price.
Inelastic demand → Price↑ & Elastic demand → Price↓
Income Elasticity of Demand (YED)
YED measure the responsiveness of demand to changes in income (real), OTRS. |
| Income Elasticity of Demand |
Types/degrees of YED
1] Positive YED [ Ey > 0]
Qdx varies positively with income and connected with normal goodsY↑ → Qdx ↑ & Y↓ → Qdx↓
Symbolically,
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| Positive Income Elasticity of Demand |
a) Greater than Unity
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| Greater than Unity Income Elasticity of Demand |
b) Equal to Unity
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| Equal to Unity Income Elasticity of Demand |
c) Less than Unity
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| Less than Unity Income Elasticity of Demand |
2] Negative YED [Ey < 0]
Qdx varies inversely with income & connected with inferior goods.Y↑ → Qdx ↓ & Y↓ → Qdx↑
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| Negative Income Elasticity of Demand |
3] Zero YED [ Ey = 0]
No any response in demand due to change in income & connected with very low priced goods. |
| Zero Income Elasticity of Demand |
Table Example of Income Elasticity of Demand
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| Table: Types of Income Elasticity of Demand |
Cross Elasticity of Demand (XED)
OTBE, XED measures the responsiveness of the demand for x-good to the change in the price of y-good. |
| Cross Elasticity of Demand |
Types/degrees of XED
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| Positive Cross Elasticity of Demand |
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| Negative Cross Elasticity of Demand |
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| Zero Cross Elasticity of Demand |
Table Example of Cross Elasticity of Demand
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| Table: Types of Cross Elasticity of Demand |
Measurement of PED (Methods)
1] Total Outlay Method
This method was developed by Prof. Alfred Marshall and it examines the change in TE as a result of change in P and Q. |
| Total Outlay Method |
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2] Point Method (Geometric Method)
This method was developed by Prof. Alfred Marshall and it is suitable measure when a change in price is very small. So, it is the measure of the proportionate change in quantity demanded in response to a very small proportionate change in price. |
| Point Method: Mathematical Proof |
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Concept & Types of Elasticity Supply
Concept of ES
Elasticity of supply refers to the degree of responsiveness in supply for a commodity to the change in any of its determinants. In other words %Δ in Qsx divided by the %Δ in its determinants.Symbolically, Es = %Δ in Qsx/%Δ in its determinants
Price Elasticity of Supply (PES)
ES means how strongly producer react if there is rise in the price of the product. So, ES is the reaction of quantity supply on price.Symbolically,
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| Price Elasticity of Supply |
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| Perfectly Elastic Price Elasticity of Supply |
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| Perfectly Inelastic Price Elasticity of Supply |
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| Unitary Elastic Price Elasticity of Supply |
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| Relatively Elastic Price Elasticity of Supply |
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| Relatively Inelastic Price Elasticity of Supply |
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