Theory of Consumer Behavior: WWW - Edutap.co - in

Economics
Theory of Consumer Behavior

Elasticity of Demand
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Agenda
Concept of Demand and Factors Affecting Demand
Shift in Demand Curve
Price Elasticity of Demand
Cross Elasticity of Demand
Income Elasticity of Demand
Practice Questions
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Concept of Demand
Effective Demand Absolute Demand
Need along with purchasing Need but purchasing Power is

Power is there not there
Example: A beggar desires milk, but has no purchasing power. Hence a beggar’s desire for milk
does not constitute an effective demand for milk. As a result a beggar cannot participate in
market activities. However, suppose this beggar becomes successful in getting a job, becomes a
helper in a shop and for his work as helper gets paid for in money. The beggar who is now a
helper earns an income, with which she can buy milk. The beggar’s demand for milk, which
earlier constituted only an absolute demand, has now become an effective demand
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Concept of Demand
Hence, for demand (for a good like milk) to exist two conditions
Effective Demand must be fulfilled:
Need along with purchasing

Power is there
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Factor Impacting Demand
As the price of a good rises the quantity demanded falls. And as
Price of Good Under Consideration
the price falls the quantity demanded would tend to increase
Substitute – Replacement – For Cow milk substitute is powdered milk

Complement – For milk complement is corn flakes
Substitutes and Complement
The quantity demanded of a good would vary positively with the
price of the substitute good, while it will vary negatively with the
price of the complementary good
For instance, when the price of powdered milk rises, consumers will
move away from powdered milk towards fresh milk. This will increase
the demand for fresh milk. On the other hand when the price of corn
flakes goes up, the demand for corn flakes will go down and as a
result the demand for fresh milk will also go down.
Factor Impacting Demand
Normally as an individual becomes richer, she would tend to
Income Level increase the consumption of each and every good. Hence, we
will observe a positive correlation between demand for a good
and the household’s income
Normally as an individual becomes richer, she would tend to

increase the consumption of each and every good. Hence, we
will observe a positive correlation between demand for a good
and the household’s income
Consumer’s tastes and preferences The demand for a good depends upon the individual
consumer’s tastes or preferences. A consumer will demand or
desire a good if and only if she has a taste for the good
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Concept of Demand Curve
Demand Curve
PO where demand is zero is called Prohibitory Price
α = a/b β = 1/b
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Positive Slope and Negative Slope
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Concept of Demand Curve
Demand Curve
PO where demand is zero is called Prohibitory Price
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Agenda
Practice Questions
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When Price changes, the person moves on the this demand curve itself
But other factors can also change the demand
For example: For example, when the income of a consumer increases without
any change in prices of goods and services, it is generally seen that she will
consume more
Similarly, there can be a change in the tastes and preferences of a consumer.

For example, I was taking non-vegetarian foods earlier. Now the doctor
advises me not to eat non-vegetarian foods on health ground. Suddenly there
is a change in my demand schedule for mutton. Even if the price falls, my
demand for mutton is zero.
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Such changes are expressed by shifts in the demand curve
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Agenda
Practice Questions
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It measures the extent to which demand for a good would increase or decrease as the own price falls or rises and other
factors remaining constant
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Concept Check
Suppose that price of a commodity falls down from Rs.10 to Rs.9 per unit and due to this, quantity
demanded of the commodity increased from 100 units to 120 units. What is the price elasticity of demand?
Solution:
Elasticity = (Change in Quantity/Q1) / (Change in Price/P1)
Elasticity = (20/100 ) / ( -1/10)

= (1/5) / (- 0.1)
= .2 / (- 0.1)
= -2
= Ignoring negative sign it becomes 2
So for every 1% change in price there would 2% change in Demand.
As price fell by 10% the demand increased by 20%
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Concept Check
When price is Rs.10 the demand for the good is 100 unit, and the price elasticity of demand is 1.5, what will happen to
demand when price fall by ten percentage points?
Solution:
Elasticity = (Change in Quantity/Q1) / (Change in Price/P1)
1.5 = (Change in Q1/100 ) / ( .1 P1/P1)
1.5 * .1 = (Change in Q1/100 )
.15 *100 = Change in Q1
15 = Change in Q1
So demand increases by 15 i.e. 15%
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Concept Check
When price is Rs.10 the demand for the good is 100 unit, and the price elasticity of demand is 1.5, what will happen to
demand when price fall by ten percentage points?
Solution:
For every 1% change in Price the demand changes by 1.5%
Since here price has decreased by 10%, so demand will increase by 15%
Initial demand is 100, so change of 15% over 100 would be 15. In other words final demand will become 115
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Important Values for Price Elasticity of Demand
When the price elasticity of demand is zero, then the demand
is perfectly inelastic.
That is, there is no change in the quantity demanded in

response to the change in price. The demand curve remains
vertical. Demand is completely unresponsive to the change in
price.
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Inelastic (PED is between 0 and 1)
If the percentage of change in demand is less than the

percentage of change in price, then the demand is inelastic.
For instance, let us say that the price of a chocolate increases

from Rs.10 to Rs.20 and the associated demand decreases from
ten chocolates to five chocolates.
So now the PED will be 50% divided by 100%, which is 0.5.

Hence, the demand here is inelastic.
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Unit Elastic (PED = 1)
When the percentage of change in demand is the same as the

percentage of change in price, then the demand is unit elastic.
For example, let us say that the price of a candy drops from
Rs.10 to Rs.5 and the demand increases from 10 candies to 15
candies.
Here, the percentage of change in demand is equal to the

percentage of change in price (50% divided by 50%, which is 1).
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Elastic (PED > 1)
If the percentage of change in demand is more than the

percentage of change in price, then the demand is perfectly
elastic.
For instance, if a 10% increase in price causes a 20% drop in

demand, then the coefficient of PED is 2, which means that the
demand is elastic.
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Perfectly Elastic (PED = Infinity)
When Demand keeps on increasing without any increase in

price, it is called Perfectly Elastic
For Example, Food grains
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Concept Check
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Price Elasticity on Demand Curve
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Agenda
Practice Questions
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Suppose We have Milk as Product 1 and Powdered Milk as Product 2
Cross Elasticity is defined as the degree of responsiveness of the quantity demanded of

X1 with respect to a change in the price P2
Some More Examples
The consumption of tea increases when there is an increase in the price of coffee
The price of petrol affects the demand for automobiles that run on diesel
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Suppose We have Milk as Product 1 and Powdered Milk as Product 2
Cross Elasticity is defined as the degree of responsiveness of the quantity demanded of

X1 with respect to a change in the price P2
The sign of cross-elasticity will indicate the nature of the relationship between the commodities, X1 and X2. If ε12 is
positive, it would imply that X1 is a substitute of X2
On the other hand when ε12 is negative X1 would be a complement of X2.
If ε12 is zero then X1 and X2 are independent.
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The sign of cross-elasticity will indicate the nature of the relationship between the commodities, X1 and X2. If ε12 is
positive, it would imply that X1 is a substitute of X2
On the other hand when ε12 is negative X1 would be a complement of X2.
If ε12 is zero then X1 and X2 are independent.
Products that complement each other show a negative cross Substitute products have a positive cross elasticity of
elasticity of demand. As the price of Y rises, the demand for X demand. As the price for Y increases, the demand for
falls. substitute X also increases.
Concept Check
If cross elasticity of demand for X is 2.5 in terms of price of Y, is commodity X a substitute or
complement of commodity Y?
X is Substitute of Commodity Y
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Concept Check
For the following demand schedule, find cross elasticity of demand for good
X when price of Y falls from Rs.5 to Rs.4. Comment on the nature of good
Solution:
Change in Demand = 3
Change in price = -1
Cross Elasticity = (3/67) / (-1/5) = -.22, so it is a complement
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Agenda
Practice Questions
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The concept of income-elasticity of demand for a good X1 (to be denoted by ε 1M) is defined as the
degree of responsiveness of the quantity demanded of X1 with respect to a change in consumer’s
income, other things remaining constant
Such a relationship defines an Engel’s curve for good X1
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Income Elasticity of Demand - Example
Suppose that the initial income of a person is Rs.2000 and quantity demanded for the commodity by him is 20 units.
When his income increases to Rs.3000, quantity demanded by him also increases to 40 units. Find out the income
elasticity of demand.
Solution
Income Elasticity = (Change in Demand/original Demand) / (Change in Income / Original Income)
= (20/20) / (1000/2000)
= 1*2= 2
So for every 1% change in income, there is 2% change in Demand
When income increased by 50%, the demand increased from 20 to 40 i.e 100%
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Income Elasticity of Demand - Example
Four Value it can have
Positive Values (> 0)
1. IED > 1
2. IED = 1
3. IED between 0 and 1
Negative Values (<0)
4. IED < 0
Zero Income Elasticity
5 IED = 0
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Positive Income Elasticity
If there is direct relationship between income of the consumer and demand for the commodity,
then income elasticity will be positive. That is, if the quantity demanded for a commodity
increases with the rise in income of the consumer and vice versa, it is said to be positive income
elasticity of demand
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Income elasticity greater than unity ( > 1)
If the percentage change in quantity demanded for a

commodity is greater than percentage change in income
of the consumer, it is said to be income greater than unity.
For example: When the consumer’s income rises by 3%

and the demand rises by 7%, it is the case of income
elasticity greater than unity
For example luxury goods such as High End Televisions

and cars
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Income elasticity equal to unity (= 1)

commodity is equal to percentage change in income of the
consumer, it is said to be income elasticity equal to unity.
For example: When the consumer’s income rises by 5% and the

demand rises by 5%, it is the case of income elasticity equal to
unity
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Income elasticity between 0 and 1

commodity is less than percentage change in income of the
consumer, it is said to be income greater than unity. For
example:
When the consumer’s income rises by 5% and the demand

rises by 3%, it is the case of income elasticity less than unity.
For example normal goods such as medicine and fuel
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Negative Income Elasticity
If there is inverse relationship between income of the consumer and demand for the commodity, then
income elasticity will be negative. That is, if the quantity demanded for a commodity decreases with the
rise in income of the consumer and vice versa, it is said to be negative income elasticity of demand
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Negative Income Elasticity
Income elasticity < 0
Quantity demanded for a commodity decreases with the rise in

income of the consumer and vice versa, it is said to be negative
income elasticity of demand
For instance, if a consumer’s income increases, then he/she

might start taking a cab instead of opting for public transport.
Public transport, in this case, is an inferior good
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Zero Income Elasticity
Income elasticity = 0
If the quantity demanded for a commodity remains constant

with any rise or fall in income of the consumer and, it is said to
be zero income elasticity of demand.
For example: In case of basic necessary goods such as salt,

kerosene etc. there is zero income elasticity of demand
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Classification of Goods on the basis
of Income Elasticity of Demand
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Agenda
Practice Questions
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Practice Questions
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Practice Questions
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Practice Questions
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Practice Questions
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Practice Questions
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Economics

Theory of Consumer Behavior

Shift in Demand Curve

Price Elasticity of Demand

Cross Elasticity of Demand

Income Elasticity of Demand

Effective Demand Absolute Demand

Need along with purchasing Need but purchasing Power is

Need along with purchasing

Substitute – Replacement – For Cow milk substitute is powdered milk

Normally as an individual becomes richer, she would tend to

PO where demand is zero is called Prohibitory Price

PO where demand is zero is called Prohibitory Price

Shift in Demand Curve

Price Elasticity of Demand

Cross Elasticity of Demand

Income Elasticity of Demand

But other factors can also change the demand

Similarly, there can be a change in the tastes and preferences of a consumer.

Shift in Demand Curve

Price Elasticity of Demand

Cross Elasticity of Demand

Income Elasticity of Demand

Elasticity = (Change in Quantity/Q1) / (Change in Price/P1)

Elasticity = (20/100 ) / ( -1/10)

So for every 1% change in price there would 2% change in Demand.

As price fell by 10% the demand increased by 20%

Elasticity = (Change in Quantity/Q1) / (Change in Price/P1)

1.5 = (Change in Q1/100 ) / ( .1 P1/P1)

1.5 * .1 = (Change in Q1/100 )

.15 *100 = Change in Q1

So demand increases by 15 i.e. 15%

For every 1% change in Price the demand changes by 1.5%

That is, there is no change in the quantity demanded in

If the percentage of change in demand is less than the

For instance, let us say that the price of a chocolate increases

So now the PED will be 50% divided by 100%, which is 0.5.

When the percentage of change in demand is the same as the

Here, the percentage of change in demand is equal to the

If the percentage of change in demand is more than the

For instance, if a 10% increase in price causes a 20% drop in

When Demand keeps on increasing without any increase in

For Example, Food grains

Shift in Demand Curve

Price Elasticity of Demand

Cross Elasticity of Demand

Income Elasticity of Demand

Cross Elasticity is defined as the degree of responsiveness of the quantity demanded of

Some More Examples

Cross Elasticity is defined as the degree of responsiveness of the quantity demanded of

On the other hand when ε12 is negative X1 would be a complement of X2.

If ε12 is zero then X1 and X2 are independent.

On the other hand when ε12 is negative X1 would be a complement of X2.

If ε12 is zero then X1 and X2 are independent.

Cross Elasticity = (3/67) / (-1/5) = -.22, so it is a complement

Shift in Demand Curve

Price Elasticity of Demand