Lilavatibai Podar High School, ISC

Academic Year 2021 – 2022

Subject: Economics Grade: 12 F,G

Topic: CHAPTER 4- ELASTICITY OF DEMAND

Meaning of Elasticity: Elasticity of any function means Percentage change in

the dependent variable caused by one percent change in one independent
variable, while all other variables remain constant.

4.2-MEANING AND TYPES OF ELASTICITY OF DEMAND- Refers to the degree

of responsiveness of quantity demanded of a commodity to a change in any
of its determinants

OR

Ratio of Percentage change in Quantity Demanded of a commodity to

Percentage change in any one determinant of Demand.

The three main types are:

• Price Elasticity of Demand –Determinant of Demand is Price of the

Commodity
• Income Elasticity of Demand- Determinant of Demand is Income of the
consumer
• Cross Elasticity of Demand- Determinant of Demand is Prices of other
goods

4.3- Price Elasticity of Demand: degree of responsiveness of quantity

demanded of a commodity in response to a change in its price

OR

Ratio of Percentage change in Quantity Demanded of a commodity to

Percentage change in its Price

ep= Percentage change in Quantity Demanded of a commodity / Percentage

change in Price

4.3.1- Degrees of Price Elasticity of Demand-

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There are 5 degrees of Price Elasticity of Demand expressed in numerical
values ranging from zero (0) to infinity (∞)

1. Perfectly Inelastic Demand: When Quantity Demanded of a Commodity

does not change with a change in its price, the Elasticity of Demand is Zero.

Quantity is on X-axis. Price is on Y-axis. Quantity demanded OQ₀ remains the

same, irrespective of whether price is OP₀ or OP₁. Demand curve D is a
vertical line, parallel to Y-axis, perfectly inelastic demand curve. The Price
Elasticity of Demand is zero. (Perfectly Inelastic) ep=0. Very rare instances.
Example- Life Saving medicines and perhaps salt.

2. Perfectly Elastic Demand Curve: When a small change in price of a product

causes a major or infinite change in its demand, the Price Elasticity of
Demand is Infinite and it is said to be Perfectly Elastic demand.

In perfectly elastic demand, a small rise in price results in fall in demand to

zero, while a small fall in price causes increase in quantity demanded to
infinity. In such a case, the demand is perfectly elastic. A change in price
causes an infinite change in the quantity demanded. ep=∞.

Very rare instances. It is applicable in a perfectly competitive market, where

the products are homogeneous and producers can sell any output at only one
price, i.e. the market price.

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Quantity is on X-axis. Price is on Y-axis. At price OP an infinitely large
quantity is demanded. But at a slightly higher price nothing is demanded.
Demand Curve D is a horizontal line, parallel to X-axis, perfectly elastic
demand curve. ep=∞.

3. Unitary Elastic Demand: When a percentage change in price of a

commodity causes an equivalent change in quantity demanded, the Elasticity
of Demand is Unitary (One). Example- If a fall in price of a commodity by 10%
causes the quantity demanded to rise by 10%, ep=1. Very rare instances

Quantity is on X-axis. Price is on Y-axis. Demand Curve DD is a rectangular

hyperbola curve (as total area of rectangles at different points on the curve is
the same). Such a Demand Curve extends towards X-axis and Y-axis, but does
not touch either.

4. Elastic Demand: When Percentage change in Quantity Demanded of a

commodity is more than the percentage change in its price, Elasticity of
Demand is greater than unitary. This is Elastic or Relatively Elastic Demand.

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ep>1 Example- If a fall in price of a commodity by 10%, causes quantity
demanded to rise by 15%, the demand is Elastic or relatively elastic. Example-
Luxury goods

Quantity is on X-axis. Price is on Y-axis. Increase in Quantity demanded from

OQ₂ to OQ₁ is relatively larger than the fall in price from OP₂ to OP₁. Demand
Curve DD is Elastic or Relatively Elastic because %age change in quantity
demanded from OQ₂ to OQ₁ is relatively larger than the %age change in price
from OP₂ to OP₁. It is a flatter Demand curve.

5. Inelastic Demand: When percentage change in the Quantity demanded of

a commodity is less than the percentage change in its price, Elasticity of
Demand is Less than Unitary. This is Inelastic or Relatively Inelastic Demand.
ep<1 Example- If a fall in price of a commodity by 10%, causes quantity
demanded to rise by 8%, the demand is Inelastic or relatively inelastic.
Example- Low priced and essential goods.

Quantity is on X-axis. Price is on Y-axis. Increase in Quantity demanded from

OQ₂ to OQ₃ is relatively smaller than the fall in price from OP₂ to OP₃.
Demand Curve DD is Inelastic or Relatively Inelastic between C and D because
%age change in quantity demanded from OQ₂ to OQ₁ is relatively smaller
than the %age change in price from OP₂ to OP₁. it is a steeper Demand curve.

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The above four panels give a summary of the description of the five degrees
of elasticity.

• It shows that the demand curve may or may not have the same
elasticity over its entire range.
• The first 3 panels in Fig. 1 above, depicts the three exceptional cases of
perfectly inelastic, perfectly elastic and unitary elastic demand curves
respectively, where a demand curve has the same elasticity throughout
its length.
• However, a downward sloping straight line demand curve as in the
fourth panel of Fig. 1 above, has elasticity that varies from infinite
elasticity at the price (vertical - Y) axis to zero at the quantity
(horizontal - X) axis. Hence it is more elastic at the upper range and less
elastic at the lower range.

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4.3.2- Methods of Measurement of Price Elasticity of Demand

1.Percentage or Proportionate method

2. Total Expenditure method

3. Point or Geometric Method

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Point Elasticity: Price elasticity is measured at a particular point on a demand
curve. Measured by Point Method or Geometric Method. Appropriate for
very small changes in price and quantity

Arc Elasticity: Price elasticity is measured over an arc or a finite range on the
demand curve. Measured by Percentage or Proportionate Method and Total
Expenditure Method. Appropriate for large changes in price and quantity

PERCENTAGE or PROPORTIONATE METHOD: is measured by Ratio of

percentage change in quantity demanded to a percentage change in price of
the commodity

ep= Percentage change in quantity demanded/Percentage change in Price

= (Change in quantity demanded/Initial quantity X 100)/ (Change in price/
Initial price X 100)

= ΔQ/Q X 100/ΔP/P X 100

= ΔQ/Q /ΔP/P = ΔQ/Q X P/ΔP

= ΔQ/ΔP X P/Q

Hence ep = ΔQ/ΔP X P/Q

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ep= Price Elasticity of Demand P= Initial Price Q= Initial Quantity ΔP=Change
in Price ΔQ = Change in Quantity

IMPORTANT POINTS to note under this method:

• Mathematically, Price elasticity is a negative number, as the demand

curve has a negative slope as the change in price on Y-axis and change
in quantity demand on X-axis are in opposite directions. However, this
is due to the inverse relationship between price and quantity demand
and elasticity of demand is not the same as slope of demand.
• Hence, we ignore the negative sign and take the absolute value and
not the sign while calculating price elasticity of demand by percentage
method. (NOTE: While solving the numerical questions)
• Further, percentage method is unit-free measure as it gives the
elasticity demand as a percentage and does not depend upon the unit
of measurement of quantity of demand or price. This is a major
advantage.

Example- Price of a commodity falls from ₹ 50 to ₹ 40 and quantity

demanded increases from 100 to 150 units. What is the Price Elasticity of
Demand by Percentage Method?

Q=100 ΔQ=150-100=50

P=50 ΔP=50-40=10

ep = ΔQ/ΔP X P/Q = 50/10 X 50/100 = 2.5.

Relatively Elastic or Elastic Demand. It shows that in this case, Demand is
more sensitive to changes in Price

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TOTAL EXPENDITURE METHOD: Elasticity of demand can be measured
considering the change in total expenditure incurred on a commodity due to
change in price of the commodity

Elastic Demand: When a fall in price results in increase in total expenditure

and a rise in price results in decrease in total expenditure, elasticity of

demand will be greater than one. ep>1 (Total Expenditure moves in opposite
direction to change in price)

In the above Schedule when price falls from ₹60 to ₹50, total expenditure
increases from ₹600 to ₹650. In the diagram, total expenditure covered by
OB> total expenditure covered by OA. Demand curve D₁D₁ is Elastic between

A and B. ep>1
Inelastic Demand: When a fall in price results in reduction in total
expenditure and a rise in price results in increase in total expenditure,

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elasticity of demand will be less than one. ep<1 (Total Expenditure moves in
same direction as change in price)

In the above Schedule when price falls from ₹60 to ₹50, total expenditure
decreases from ₹600 to ₹550. In the diagram, total expenditure covered by
OB< total expenditure covered by OA. Demand curve D₂D₂ is Inelastibetween

A and B. ep<1
Unitary Elastic: When total expenditure does not change with change in price

of the commodity, Elasticity of Demand is Unitary. ep=1

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In the above Schedule when price falls from ₹60 to ₹50, total expenditure
remains the same at ₹600. In the diagram, total expenditure covered by
OB=total expenditure covered by OA. Demand curve D₃D₃ is a rectangular

hyperbola. ep=1

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Total Expenditure (TE) is on X-axis. Price is on Y-axis. When price falls from
OP to OP₁, TE increases from OM to OM₁. Ep>1. When price falls from OP₁ to
OP₂, TE remains unchanged at OM₁. Ep=1. When price falls from OP₂ to OP₃,
TE decreases from OM₁ to OM. Ep<1. Between T and B zone, Ep>1. Between B
and C zone, Ep=1. Between C and T₁ zone, Ep<1

TE method indicates whether Price elasticity is greater than, equal to or less

than 1, it does not give the exact measurement

POINT METHOD (GEOMETRIC METHOD):

ep= Line segment below the point on the Demand Curve/ Line segment
above the point on the Demand Curve

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On a Straight Line Demand Curve: On a straight line Demand Curve AB, price
elasticity of Demand at points R and K-

Ep at point R= Lower line segment/ Upper line Segment=RB/RA

Ep at point K= Lower line segment/ Upper line Segment=KB/K

Price Elasticity of Demand at different points on a Straight Line (Linear)

Demand Curve AB:

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ep at A (Demand curve AB touches Y-axis) = Line segment below A/ Line
Segment above A= AB/0=ꭃ (Infinity) ep = ∞

ep at E= Line segment below E/ Line Segment above E= EB/EA= >1 (EB>EA)

(Relatively Elastic) ep > 1

ep at mid-point D= Line segment below D / Line Segment above D= DB/DA=

1 (DB=DA) (Unitary Elastic) ep = 1

ep at C= Line segment below C / Line Segment above C= CB/CA= <1 (CB<CA)

(Relatively Inelastic) ep < 1

ep at B (Demand Curve AB touches X- axis) = Line segment below B / Line

Segment above B= 0/BA= 0. ep = 0

On a straight line Demand curve, as we move downwards from left to right,

e
Price elasticity of Demand ( p) varies from Infinity at Y-intercept to Zero at

X-intercept; ep >1 above mid-point (Elastic demand), ep =1 at mid-point

(Unitary elastic demand), ep <1 below mid-point (Inelastic Demand).

Hence a Straight line (Linear) Demand Curve is more Elastic towards its left
hand end and Less Elastic towards its right hand end

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Price Elasticity of Demand on a Non-Linear Demand Curve:

To measure Elasticity of Demand at point R on non-linear Demand Curve DD,

draw a line AB tangent to DD at R. Slope of DD at R = Slope of AB. Hence
Elasticity of Demand of non-linear Demand Curve DD at R = Elasticity of

Tangent AB at R. ep at R = Lower Line Segment/Upper Line Segment =

BR/RA

4.3.4-Factors affecting Price Elasticity of Demand:

1. Availability of Substitutes: A commodity with more and close

substitutes has an Elastic Demand. A small fall in its price will induce
consumers to buy more of that commodity rather than the substitutes.
Example- Tea/Coffee, Pepsi/Coke, Various brands of pizza. A
commodity with few and weak or no substitutes has an Inelastic
Demand. The consumers will have to buy it irrespective of whether
price is high or low. Example- Milk, Salt
2. Nature of the commodity: The Demand for necessities is Inelastic and
the Demand for luxuries is Elastic, example- air-conditioners, TV etc.
3. Proportion of income Spent: The smaller the proportion of income
spent on a commodity, the smaller the elasticity of Demand and vice-
versa. Example- Demand for salt, newspaper, etc is inelastic while the
demand for clothes, furniture etc. on which the consumer spends a
larger proportion of income is relatively more Elastic
4. Number of Uses of a Commodity: The more the number of uses of a
commodity, the greater the price elasticity of Demand. Example-
Electricity has multiple uses, like lighting, heating, cooking. If it is

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 expensive, it will be used for lighting only. If it is cheaper, it may be
used for heating and cooking also. Hence the quantity demanded will
change greatly with a change in price, the demand for electricity will be
more Elastic
5. Time Factor: Price Elasticity is generally low for short period as
compared to long period. This is due to i) In the short-run, consumers
may not adjust their tastes and preferences, but in the long-run, they
may be able to do so. And ii) If price of a commodity rises, demand for
it in the short-run will be relatively Inelastic as substitutes may not be
available. But in the long-run, new and less expensive substitutes
maybe available and consumers may switch over.
6. Possibility of Postponement of Consumption: Demand for a commodity
is Elastic if its consumption may be postponed. Example-Clothes,
furniture etc. But consumption of food cannot be postponed, hence its
demand is Inelastic
7. Price Range: Demand for a commodity tends to be Inelastic at very
high and very low prices and Elastic within the moderate range. When
a commodity is priced very high, the demand for it comes from very
rich persons and rise or fall in its price does not matter. When a
commodity is priced very low, most consumers would have bought it
and a further fall in price would not lead to appreciable change in
quantity demanded
8. Habits of consumers: If consumers are habituated to use a certain
quantity they will continue despite a price rise. Example- cigarettes for
smokers. The quantity demanded will not significantly change. Hence
Inelastic Demand
9. Income of consumer: Rich consumers have Inelastic Demand as rise or
fall in price will normally not impact their budget. Demand from
middle class and poor is relatively elastic as price changes impact their
budget.

Importance of Elasticity of Demand:

1. Business Decisions: Increasing price of a good is beneficial if elasticity

of demand for its substitutes is low as otherwise consumer will easily
shift to substitutes with increase in price of the product. Also it is

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 beneficial to increase production of those goods which have high
income elasticity of demand.
2. Importance to Monopolist: A monopolist practices price
discrimination. Hence, he will charge higher prices to consumers who
have inelastic demand and lower prices to consumers with elastic
demand, for his product.
3. Determination of Factor Prices: If the demand for labour and the
demand for the product produced by that labour is elastic, then labour
unions have less bargaining power to increase wages. Because increase
in wages will lead to increase in prices due to which the demand for
the product may decrease causing decrease in demand for labour and
causing unemployment. But if demand for a product and its labour is
inelastic, trade unions can bargain better for increase in wages.
4. Important to formulate Government Policies: If government wants to
impose higher GST on a good, to increase revenue, it can do so more
easily on a product with inelastic demand, as it will not cause a
decrease in the demand for the product greatly. Government can also
formulate policy on granting subsidies based on elasticity of demand
for the commodity.
5. Importance in International Trade: Government will impose export &
import duties, based on the effect of these duties on import & exports,
which also depends upon elasticity of demand for these items.
6. Change in Exchange Rate: Exchange rate is the rate at which one unit of
the currency of a country is exchanged for currencies of other
countries. Example- 1 USD = ₹ 75/-. The home currency may be
devalued, if demand for country’s exports is elastic.
7. Incidence of Taxation: Incidence of Taxation refers to the person who
ultimately bears the money burden of the taxes paid. In case of GST,
the money burden is more on the seller if the good has elastic demand
and more on the consumer if the good has inelastic demand. Hence
Government needs to keep this aspect in view while deciding about
GST for a commodity.
8. Paradox of Plenty: Example- Agricultural produce has inelastic
demand. Hence a bumper crop forces the farmers to sell at very low
prices even below cost of production, as agricultural produce is

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 perishable. The income of the farmer is reduced instead of increasing
due to bumper harvest. This is the Paradox of Plenty. Government
steps in to buy the products at a minimum support price.

4.4- INCOME ELASTICITY OF DEMAND: measures the degree of

responsiveness of quantity demanded of a commodity to a change in income
of the consumers.

ey= Percentage Change in Quantity Demanded / Percentage change in

Income

= ΔQ/Q / ΔY/Y

= ΔQ/ ΔY X Y/Q

4.4.1- TYPES OF INCOME ELASTICITY OF DEMAND:

1. Positive Income Elasticity: The Quantity Demanded of a commodity

increases with an increase in income and decreases with a decrease in
Income. Goods with Positive Income Elasticity are Normal Goods. Normal
goods Income elasticity (Positive) can be classified into three categories:

I. Income Elastic: Percentage Change in Quantity Demanded of a

commodity is greater than the percentage change in Income. Ey>1.
Examples- Luxury goods, i.e. Cars, TV, jewellery etc.
II. Income inelastic: Percentage Change in Quantity Demanded of a
commodity is Smaller than the percentage change in Income. Ey<1.
Examples- Necessity Goods like food, soap, toothbrush etc.
III. Unitary Income Elasticity: Percentage Change in Quantity Demanded of
a commodity is equal to the percentage change in Income. Ey =1. Very
rare instances

2. Negative Income Elasticity: The Quantity Demanded of a commodity

decreases with an increase In Income of the consumer and vice versa. Goods
with Negative Income Elasticity are Inferior Goods. Example- Income
Elasticity of inferior goods like Maize and Jowar are Negative. With increase
in income, a consumer would switch over to superior goods like wheat and
rice.

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3. Zero Income Elasticity: The Quantity Demanded remains unchanged with a
rise in Income. Inexpensive Goods of Necessities like salt, matchbox etc. are
Zero Income Elastic because an increase in income beyond a certain level
would not change the Quantity Demanded of these goods.

4.5- CROSS ELASTICITY OF DEMAND: Percentage Change in Quantity

Demanded of a commodity with respect to the Change in the Price of its
Related Commodity.

exy= Percentage Change in the Quantity Demanded of Commodity X /

Percentage change in Price of Y

= ΔQx/Qx/ ΔPy/Py

= ΔQx/Qx X Py/ΔPy

= ΔQx / ΔPy X Py /Qx

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 TYPES OF CROSS ELASTICITY OF DEMAND:

Positive Cross Elasticity of Demand: Cross Elasticity is Positive when the

Quantity Demanded of the Related good X increases due to an increase in
the price of the Commodity Y and vice versa. E.g. Substitutes like
Tea/Coffee. There is an increase in the Quantity demanded for Tea (X) due
to an increase in price of Coffee (Y), but the Quantity Demand for Coffee
reduces.

Cross Elasticity is Positive for Substitutes (change in Quantity Demanded

for Tea and the change in price of Coffee move in the same direction- have
same signs)

Negative Cross Elasticity of Demand: Cross Elasticity is Negative when the

Quantity Demanded of the Related good X decreases due to an increase in
the price of the Commodity Y and vice versa. E.g. Complementary goods
like Bread/Butter. There is a Decrease in the Quantity Demanded for
Bread if the Price of Butter Increases (also, the quantity demanded for
butter decreases).

Cross Elasticity is Negative for Complementary goods (change in Quantity

Demanded for Bread and the change in price of Butter move in the
opposite direction - have opposite signs)

Zero Cross Elasticity of Demand: Cross Elasticity is Zero when the Quantity
Demanded of the good X does not change due to a change in the price of
the Commodity Y. E.g. Goods not related to each other, like clothes and
TV.

Cross Elasticity is Zero for Commodities Not Related to Each Other (There
will be No Change in Demand for TVs due to Change in Prices of Clothes)

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 THE END

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