Report on Elasticity

Research Question – To investigate the various factors that affect the elasticity of
demand of different types of goods.

Elasticity is a powerful economic concept that gives a fair estimation of a dependent economic
variable of a product when we alter an influencing economic factor, by quantifying its
responsiveness.

Understanding elasticity, requires the knowledge of demand, price and elasticity. Demand is the
willingness and ability to purchase a commodity or service at a particular time and price, while price
is the amount of money given or set as consideration for the sale of a product (Merriam-Webster).
Supply goes hand-in-hand with demand, being the quantity of a product offered by a producer at a
particular time and price.

The relevance of this is as follows:

 To The Producer: gives an idea of the demand at different prices of the product.
o Allows gain maximum profits according to the elasticity of the product. If it is
inelastic, a businessman would keep a high price, but for an elastic good, demand
may increase more in proportion to the drop in price, lending more profit margin.
o We can expand this idea to the international level when we talk of imports and
exports between countries.
 Price discrimination:
o It is the setting of different prices for the same product in different markets/sub-
markets where the elasticity for the product is different.
o Allows maximum reaping of profit from each market
 Mechanization:
o If done for an elastic product, this will lead to cheaper prices so more demand, and
that increase in demand would be fulfilled by more workers (therefore not causing
unemployment).
o For an inelastic product, mechanization would cause unemployment.
 Government policies:
o If a product is inelastic, the government sets minimum selling prices because the
price of an inelastic product can decrease sharply with an increase in supply and
competition.
o Example - agriculture to prevent from the paradox of poverty for farmers, where
exceptional harvest bring poverty because the surplus of supply creates a sharp drop
in prices.

The following table details the relation between the prices, supply and demand. Ceteris Paribus
applies.

Factors Price Demand Supply

Price - Inverse relationship Direct Relation, since
 (more variation in if the price of the
elastic goods than product is expands,
inelastic), because as the producer would
the price expands want to expand the
people would be supply for a magnified
willing to purchase it profit margin
Demand More demand exists - Producers attempt to
only when the prices keep Supply and
are contracted – demand equal.
Inverse Relation
Supply If there is more supply Producers attempt to -
of a product, they keep Supply and
would want to demand equal.
increase its price so
that profits can
increases substantially
– Direct Relation

Demand Curve (Demand and Price) –

Supply Curve (Supply and Price) –

Demand-supply curve (Inter-relation of Price, Demand and Supply)—

This curve is made by over-lapping the demand curve and supply curve. This combined graph shows
us the point where the demand and supply meet, which is called the equilibrium point. If the
product is sold at the Price P*, there will be equal supply and demand and hence there will be no
surplus (excessive supply – found at prices higher than P*) or shortage (less supply – found at prices
lower than P*).

Relation of Price, Demand and Supply with Price Elasticity of demand-

The Price elasticity of Demand will cause a change in the gradient of the demand curve. It has
therefore no direct relation with supply. If the price elasticity of demand is low, the demand curve
will have a steep gradient because even a large price change will cause a small change in demand;
and vice-versa applies.
An Example of the Relationship:-

If the producers decide to increase the price of coffee, they will aim to simultaneously produce
more, however since coffee is an elastic product, doing so will significantly contract their demand
due to the low-levelled demand curve of coffee. Therefore, they will search for an equilibrium price
at which their supply is equal to their demand by reducing their prices.
Price Elasticity of Demand for each household and product:

Increase
Table
H1 H2 H3 H4 H5
Salt 0 0 0 0 0
Choc -0.833333333 -1 0 -1 0
Gold -5 -5 -5 -2 0

Decrease
table
H1 H2 H3 H4 H5
Salt 0 0 0 0 0
Choc 0 -1 0 -0.5 0
Gold -7.5 -5 -10 -2 0

The salt consumption is fixed for each family.

Family 1 –

They occasionally eat chocolates, but they are not very enthusiastic about it. In the interview, he said
that they eat around 1 chocolate in a month of Rs.120. Even though they consume this product
rarely, they would still reduce it if the price grows. If it decreases, however, they wouldn’t increase
consumption.

This year they bought 20g of gold as investment. However if the price of gold would increase, they
would not view it as fit for investment. They would buy 50g at a price decrease since when the price
increases again more money will be gained.

Family 2 –

The family has children who like chocolates. They consume around 50 chocolates a year, but that
quantity would be affected if the price of the chocolate increases (they would buy less of that
particular chocolate or move onto another one), but on decrease more consumption would probably
take place. This demonstrates the elastic nature of the product.

The family doesn’t invest much in gold, hardly 10g a year. Gold being a very elastic good, an increase
of 20% will prevent them from buying it at all, and a decrease would promote them to buy double
the current quantity.

Family 3 –

This family consists of 4 children (youngest >15 years old), so chocolates aren’t consumed at all. It is
only when guests come do they buy chocolates and gift them chocolates. This year around 5
chocolates were bought for the guests. No matter the price, they would still buy 5 chocolates in the
year. For this reason, in their family’s context, chocolates suddenly become inelastic with 0
elasticity!

Not much investment in gold. So an increase would demotivate them, but a decrease would make
them by 3 times the gold.

Family 4 –
Their family is a combined one.

For the kids in their family, they frequently buy them chocolates. Around 100 in a year, but this value
will change with the price.

The eldest retired man in the family invests as alternative income to the family in gold and stocks.
This year he bought around 100g of gold, and by the end of the year, he will sell that gold to re-
invest, through which we earns around Rs.50000-100000. For his dealings, gold is very elastic.

Family 5 –

Family 5 is not affected with an increase of decrease in the prices of chocolates. It consumes around
1 chocolate a month, and that consumption doesn’t change.

They do not invest in gold, so even with a 20% decrease in price, they do not buy the gold. So, gold is
not inelastic for them because it is a need, but because it is not consumed at all.

The observations for each family can be accounted for the factors that affect the elasticity.

The type of good has probably the most impact on elasticity because the essentiality of the good will
define its elasticity. An essential good (a need) will be inelastic, as whatever the prices may be, those
products need to be consumed. On the other hand, wants will be elastic and desires will be much
more, since users aren’t force into buying them. The significance of this classification is that it will
change according to the needs and wants of the market/household/individual. In the case of family
5, gold is simply not a major want that they would like to invest their money in, and neither is it a
need, so it is not consumed, and in family 3, chocolates were not a want, but a need at specific times
when they wanted to gift it to a guest, so in that respect it is an inelastic good, but for a large
population chocolates are elastic. Similarly for an alcohol-consumer, alcohol become inelastic as it
becomes a habit-induced necessity.

Other factors are mentioned in the table:

Factor
High competition also makes products more
elastic, like
Other products like water, electricity are basic
amenities and so are inelastic. However since
there are many uses of them, if prices do
change, the usage of the product will
increase/decrease by altering the use-cases of
the product.
Also, the high income band of consumers will
not be much affected by changes in prices,
hence any product will be more inelastic to
high-income than low-income groups.
Example
If salt (an inelastic good) from Tata increases its
prices, people would prefer other salt
manufacturers.
If electricity prices increase, people will stop
using the AC/geyser too much. Therefore
products with more uses have more elasticity.
Increase In price of milk will be substantial for a
person who can hardly afford enough. For a rich
man, though, this change is trivial.

Urgent goods will become more inelastic in Life-saving medicines that are urgent are
nature inelastic
Price range of the product affects the elasticity. (20% increase of Rs.10 chocolate = Rs.12 - >
Higher the price, more the elasticity. Rs.2 difference;
 20% increase of Rs.10 lakh car = Rs.12 lakh -> 2
lakh difference)

Until now, we have discussed how price and elasticity affect the demand of the product, but there
exist many other non-price determinants of demand. Price causes movement along the demand
curve, but the non-price determinants cause a shift in the demand curve itself. If the demand
increases through these factors, the curve shifts to the right, if decreased, to the left:

These factors include:

 consumer income:
o For superior goods or normal goods (superior and inferior variants don’t exist), an
increase in consumer income will increase their demand, because people would
switch from cheap variants to superior ones, and would buy more of normal goods
o For inferior goods the demand would decrease
 marketing strategies/advertisements
o such methods can be used to bring the product to the attention of more consumers,
to increases demand
 tastes and preferences of the market
o The general trend in the market will decide the flow of consumption in the market.
o In places where coffee is the trend, tea shops will not meet much success
 demographics of the region
o Demographics include the age and gender distribution, culture, social structure,
common trends influenced by surroundings (climate, etc.)
o Selling an efficient form of rain-protection would be successful in areas like the
North-East of India or other areas that receive high rainfall
 governmental interference
o If the government creates laws favouring the product its demand may increase
o In places where plastics are banned, jute and cloth bags are favoured causing an
increase in their consumption
Appendix
Questionnaire
Questionnaire
Greetings. This questionnaire is created to calculate the influence of the price of product on the
consumption of that product by households. As you will observe, some products are different than
others: the consumption of some may change radically with price, but some may not change at all.
The under-lying economic concept of this observation is ‘Price Elasticity of Demand’. If the price
elasticity of demand is high, small changes in price will result in large changes in the quantity
demanded and vice-versa.

Please fill the tables below:

Name of Product: Salt

Price (P in Rs.) Quantity Demanded (Q in units)

Current Price
Increased by 20%
Decreased by 20%

Select 1 Product from Category 2 and fill the table below:

Name of Product: Chocolates

Price (P in Rs.) Quantity Demanded (Q in units)

Current Price
Increased by 20%
Decreased by 20%

Select 1 Product from Category 3 and fill the table below:

Name of Product: Gold

Price (P in Rs.) Quantity Demanded (Q in units)

Current Price
Increased by 20%
Decreased by 20%

Thank you for your cooperation.