Elasticity Continued……

DETERMINANTS OF PRICE ELASTICITY OF

DEMAND: Some products are elastic (buyers
are price sensitive), and some products are
inelastic (buyers are not price sensitive). What
makes people more sensitive to one product’s
price change compared to another product’s
price change? Some people will choose to not
buy a car if its price increases by 10%, but are
unaffected by an increase of 10% in the price
of a bag of salt.
 Relationship between AR, MR and
Elasticity of Demand!
• The relationship between AR, MR and
elasticity of demand is very useful at any level
of output.
• This relationship is very useful in the price-
determination under different market
conditions. It has been discussed that average
revenue curve of a firm is the same thing as
the demand curve of the consumer for the
product of the firm.
 Elasticity Continued……
1.Nature of commodity:
Commodities are classified as necessities,
luxuries and comforts.
• (i) A necessity that has no close substitute (salt,
newspaper, polish etc.) will have an inelastic
demand because its consumptions cannot be
postponed. Moreover, consumers purchase
almost a fixed amount of a necessity per unit of
time whether the price is somewhat higher or
lower.
DETERMINANTS OF PRICE ELASTICITY
OF DEMAND
(ii) Demand of luxuries is relatively more elastic because
consumption of luxuries (TV. sets, decoration items,
etc.) can be dispensed with or postponed when their
prices rise.
(iii) Comforts have more elastic demand than necessities
and less elastic in comparison to luxuries.
• Commodities arc also classified as durable and
perishable. Demand for durable goods is more elastic
than perishable goods (non-durable) because when the
price of former increases, people either get the old one
repaired or buy a second hand.
DETERMINANTS OF PRICE ELASTICITY
OF DEMAND
2. Range of substitutes:
• A commodity has elastic demand if there are close
substitutes of it. A small rise in the price of a commodity
having close substitute will force the buyers to reduce the
consumption of the commodity in favour of substitutes.
• A lower price will attract the buyers’ of the other
substitutes to purchase the commodity. If no substitutes
are available, demand for goods tends to be inelastic.
Demand for salt is highly inelastic because it has no
substitute.
• For example, if the price of coffee rises, the demand for
coffee decreases and the demand for tea increases and
vice-versa.
DETERMINANTS OF PRICE ELASTICITY
OF DEMAND
3 . Goods having several uses or Number of uses of a
commodity:
• If a commodity has several uses, it has an elastic
demand. For example, electricity has several uses. It is
used for lighting, room heating, cooking, etc. if the
tariffs of electricity increase, its uses will be restricted
to important uses. If the tariffs of electricity increases,
its uses will be restricted to important uses. On the
other hand, it will be withdrawn for less important
uses.
DETERMINANTS OF PRICE ELASTICITY
OF DEMAND
4. Possibility of postponement of purchase:
• If the use or purchase of a commodity can be
postponed for some times, then the demand of
such commodity will be elastic.
• For example, if cement, bricks, wood and other
building materials become costlier, people will
postpone the construction of houses. Therefore,
price elasticity of building materials will be high.
• On the other hand, goods whose demand cannot
be postponed, their demand will be inelastic.
DETERMINANTS OF PRICE ELASTICITY
OF DEMAND
5. Importance of the commodity in consumers
budget: (Proportion of income spent)
• Goods on which a consumer spends a very small
proportion of his income, e.g. salt, newspaper,
tooth paste etc. the demand will nor be much
affected by a change in the price. Hence, it will be
inelastic. On the other hand, goods on which the
consumer spends a large proportion of his
income e.g clothes, food etc. their demand will
be elastic.
DETERMINANTS OF PRICE ELASTICITY
OF DEMAND
6. Range of prices:
• At a very high or very low range of prices, demand
tends to be inelastic Demand for high priced
commodities come from only the rich people who give
little importance to price.
• A change in the price of high-priced commodities will
not generally affect the demand of rich consumers.
• On the other hand low priced commodities are either
necessities or a small part of income is spent an them.
Therefore, their demand is inelastic.
DETERMINANTS OF PRICE ELASTICITY
OF DEMAND
• 7. Income level:
• People with high incomes are less affected by
price changes than people with low incomes. A
rich man will not curtail his consumption of
vegetables, milk, fruits even if their prices rise
significantly and he will continue to purchase the
same amount as before.
• But a poor man cannot do so. Thus, the
distribution of national income has an important
bearing on the elasticity of demand
DETERMINANTS OF PRICE ELASTICITY
OF DEMAND
8. Time:
In the short-run the demand is inelastic while
in the long-run demand is elastic. The reason
is that in the long-run consumer can change
their habits and consumption pattern.
DETERMINANTS OF PRICE ELASTICITY
OF DEMAND
• 9. Joint demand:
• Elasticity of demand for a commodity is also
influenced by the elasticity of its jointly
demanded commodities.
• If the demand for pen is inelastic then the
demand for ink will be inelastic. Generally, the
elasticity of jointly demanded goods is
inelastic.
 Elasticity and the Effect of a Tax
Change on the Price of the Product
 Elasticity and the Effect of a Tax
Change on the Price of the Product
• If a government increases the sales tax on a product by 50 cents,
does that mean that the equilibrium price of the product will
increase by 50 cents? The answer is no. Typically, the equilibrium
price will increase less than 50 cents. How much it will increase
depends on the product’s elasticity. Let’s take a look at an example.
• Let’s assume that a state government increases the tax on gasoline
by 50 cents. This means that the cost of supplying the gasoline
increases by 50 cents. In the graph below, the supply curve shifts
leftward. Note that the vertical difference between supply curve S1
and supply curve S2 is 50 cents (the increase in the cost of
supplying the gasoline). The equilibrium price, however, did not
increase by 50 cents, because the demand curve is sloped at an
angle. The burden of any tax is typically shared between consumers
and suppliers. In the graph below, the tax is shared equally as the
price increases by 25 cents.
 Elasticity and the Effect of a Tax
Change on the Price of the Product
• In the graph below, the demand curve is steeper
than the demand curve in the graph above. This
means that the product is less elastic.
Consequently, most of the burden of the tax is
born by the consumers. In general, for less-elastic
products (steeper demand curves), the burden of
the tax is mostly on the consumers. For more-
elastic products (flatter demand curves), the
burden of the tax is mostly on the suppliers.
 Elasticity and the Effect of a Tax
Change on the Price of the Product
 Cross Price Elasticity of Demand
• The concept of cross-price elasticity is used to examine the
responsiveness of demand for one product to changes in the
price of another. Point cross-price elasticity is given by the
following equation:
Cross Price Elasticity of Demand
 Income Elasticity of Demand
• What is the Income Elasticity of Demand?
• Income elasticity of demand refers to the
sensitivity of the quantity demanded for a certain
good to a change in real income of consumers
who buy this good, keeping all other things
constant. The formula for calculating
income elasticity of demand is the percent
change in quantity demanded divided by the
percent change in income. With income elasticity
of demand, you can tell if a particular good
represents a necessity or a luxury.
 Income Elasticity of Demand
• The formula for income elasticity is:
• Income Elasticity = (% change in quantity demanded) / (% change
in income)
• An example of a product with positive income elasticity could be Ferraris.
Let's say the economy is booming and everyone's income rises by 400%.
Because people have extra money, the quantity of Ferraris demanded
increases by 15%.
• We can use the formula to figure out the income elasticity for this Italian
sports car:
• Income Elasticity = 15% / 400% = 0.0375
• An example of a good with negative income elasticity could be cheap
shoes. Let's again assume the economy is doing well and everyone's
income rises by 30%. Because people have extra money and can afford
nicer shoes, the quantity of cheap shoes demanded decreases by 10%.
• The income elasticity of cheap shoes is:
• Income Elasticity = -10% / 30% = -0.33
 AR, MR and Elasticity of Demand (With Diagram)
• The relationship between AR, MR and elasticity of demand is very
useful at any level of output.
• This relationship is very useful in the price-determination under
different market conditions. It has been discussed that average
revenue curve of a firm is the same thing as the demand curve of
the consumer for the product of the firm.
• It means AR curve is from the point of view of seller but the same
is the demand curve from the consumer’s point of view. It means
elasticity of demand at any point on the demand curve is the same
thing as the elasticity on the demand curve. Before we discuss the
mutual relationship between AR, MR and Elasticity of demand, let
us study these concepts briefly. AR is the revenue per unit of output
sold. AR is the ratio of TR to total output. Besides, AR is nothing but
the price.
AR, MR and Elasticity of Demand
(With Diagram)