ELASTICITY OF DEMAND

AND ITS
DETERMINANTS
WHAT IS ELASTICITY ?

“Elasticity is a measure of a
variable's sensitivity to a
change in another variable,
most commonly this
sensitivity is the change in
price relative to changes in
other factors. It is
predominantly used to assess
the change in consumer
demand as a result of a
change in a good or service's
price.”
 ELASTICITY OF DEMAND

ELASTICITY OF
DEMAND : In business
and economics, elasticity
of demand refers to the
degree to which
individuals, or consumers
change their quantity
demanded in response to
price changes.
 TYPES OF ELASTICITY OF DEMAND

PRICE

• PRICE ELASTICITY OF
ELASTICITY
OF DEMAND
[PED]
DEMAND [PED]

• INCOME ELASTICITY OF
DEMAND [IED] TYPES OF
ELASTICI
TY OF
• CROSS ELASTICITY OF DEMAND
DEMAND [XED] INCOME
ELASTICI
CROSS
ELASTICIT
TY OF Y OF
DEMAND DEMAND
[IED] [XED]
TYPES OF PRICE ELASTICITY OF
DEMAND

• PERFECTLY
ELASTIC
DEMAND :
• Here, ed=∞ and
Demand curve is
parallel to X-axis.
• PERFECTLY
INELASTIC
DEMAND:
• Here ed=0, and
Demand curve is
parallel to Y-axis.
• RELATIVELY
INELASTIC
DEMAND:
• Here ed < 1, and
Demand curve appears
to be a little steeper.
• RELATIVELY
ELASTIC DEMAND:
• Here ed > 1, and
Demand curve appears
to be a little flatter.
• UNITARY ELASTIC
DEMAND:
• Here ed = 1, and
Demand curve appears
to be a rectangular
hyperbola.
 CALCULATION OF ELASTICITY OF
DEMAND

PRICE ELASTICITY OF DEMAND INCOME ELASTICITY OF DEMAND CROSS ELASTICITY OF DEMAND

[PED] [IED] [XED]
• PED = • IED = • XED =
METHODS FOR CALCULATING PRICE
ELASTICITY OF DEMAND

▪METHOD
  1 : PROPORTIONATE METHOD :-
Ed
=
=
METHOD 2:
GEOMETRIC /
POINT METHOD :-
Ed =
 
CASE 1: LINEAR DEMAND
CURVE
Consider a Demand curve AB, and
we have to find elasticity at a point
P.
According to the formula,
Ed = =
  = = 1.5
CASE 2: NON-LINEAR
DEMAND CURVE
Consider a Demand curve DD,
and we have to find elasticity at a
point P.
First we must construct a tangent
to point P , then apply formula.
According to the formula,
Ed = =
  = = 2
▪ METHOD 3 : EXPENDITURE / TOTAL OUTLAY METHOD
▪ According to this method, elasticity of demand can be measured
by considering the change in price and the subsequent change in
the total quantity of goods purchased and the total amount of
money spent on it.

Important Formula,
TOTAL EXPENDITURE = QUANTITY PURCHASED x
PRICE
▪ CASE 1 :
▪ If with a fall in price (demand increases) the total expenditure
increases or with a rise in price (demand falls), the total expenditure
falls, in that case the elasticity of demand is greater than one i.e. ED >
1.
PRICE QUANTITY TOTAL
EXPENDITURE
▪ 50 2 100
25 7 175
20 10 200
▪ CASE 2 :
▪ If with a fall in price (Demand rises), the total expenditure also falls,
and with a rise in price (Demand falls) the total expenditure also rises,
the demand is said to be less classic or elasticity of demand is less than
one (ED < 1).
PRICE QUANTITY TOTAL EXPENDITURE
20 5 100
15 10 150
5 40 200
▪ CASE 3 :
▪ If with a rise or fall in the price (demand falls or rises respectively),
the total expenditure remains the same, the demand will be unitary
elastic or ED = 1.
RELATIONSHIP BETWEEN TOTAL REVENUE
AND ELASTICITY OF DEMAND

▪ The total amount paid by buyers, and received as revenue by sellers.

TOTAL REVENUE = P × Q.

CASE 1 : DEMAND IS INELASTIC (ED<1)

In panel (a), the demand curve is inelastic.
In this case, an increase in the price leads to a
decrease in quantity demanded that is proportionate
ly smaller, so total revenue increases. Here an increase
in the price from 4 to 5 causes the quantity demanded to
fall from 100 to 90. Total revenue rises from 400 to 450
▪ CASE 2 : DEMAND IS ELASTIC (ED>1)

In panel (b), the demand curve is elastic. In this case, an

Increase in the price leads to a decrease in quantity demanded
that is proportionately larger, so total revenue decreases. Here
an increase in the price from 4 to 5 causes the quantity
demanded to fall from 100 to 70. Total revenue falls from 400 to 350.
▪ CASE 3 : DEMAND IS UNITARY ELASTIC (ED=1)

If demand is unit elastic (a price elasticity exactly equal to 1), total revenue remains
constant when the price changes.
 PED>1 PED<1 PED=1
PRICE INCREASE REVENUE FALLS REVENUE RISES REVENUE
CONSTANT
PRICE DECREASE REVENUE RISES REVENUE FALLS REVENUE
CONSTANT
FACTORS AFFECTING ELASTICITY OF
DEMAND

▪ NATURE OF GOOD :-
▪ The elasticity of demand for a good depends upon the nature of the
good, i.e., whether the good is a necessity, comfort or a luxury good.
Goods that are a necessity like food, vegetables etc are typically
inelastic, meaning that a change in price is unlikely to impact demand.
Comfort and luxury goods like AC, refrigerator tend to be more elastic
because changes in an economic variable might lead to less consumer
demand.
▪ INCOME LEVEL :-
▪ Elasticity of demand for any commodity is generally less for higher
income level groups or very low income level groups. It happens
because rich people are not influenced much by changes in the price of
goods while the very poor people have very scarce demand for
necessities only. But, middle income group are highly affected by
increase or decrease in the price of goods. As a result, demand for
middle income group is highly elastic.
▪ POSTPONEMENT OF CONSUMPTION :
▪ If there are possibilities of postponing the consumption of the goods its
demand is highly elastic. On the other hand if the goods have to be
consumed immediately the demand is less elastic as one has to demand
at the available price e.g., medicines.
▪ HABIT OF CONSUMERS :-
▪ Commodities, which have become habitual necessities for the
consumers, have less elastic demand. It happens because such a
commodity becomes a necessity for the consumer and he continues to
purchase it even if its price rises. Alcohol, tobacco, cigarettes, etc. are
some examples of habit forming commodities.
▪ AVAILABILITY OF SUBSTITUTES
▪ If close substitutes for the commodity are available, the demand for
the commodity will be elastic. The reason is that even a small rise in
its prices will induce the buyers to go for its substitutes. For example,
a rise in the price of Pepsi encourages buyers to buy Coke and vice-
versa. However, the demand for a commodity (such as salt) having no
close substitutes is inelastic.
▪ LEVEL OF PRICE :-
▪ Level of price also affects the price elasticity of demand. Costly goods
like laptop, Plasma TV, etc. have highly elastic demand as their
demand is very sensitive to changes in their prices. However, demand
for inexpensive goods like needle, match box, etc. is inelastic as
change in prices of such goods do not change their demand by a
considerable amount
▪ SHARE IN TOTAL EXPENDITURE:-
▪ Demand for a commodity is inelastic if very small proportion of total
expenditure is spent on it eg demand for match box , needle etc. when
price of such goods change, almost same quantity of these goods
change , almost same quantity of these goods is purchased by the
consumer. However , if large proportion of total expenditure is spent
on a commodity, then demand of such a commodity will be elastic like
demand of car, A.C.
▪ NUMBER OF USES
▪ Demand for a commodity which has various uses is generally
elastic.For eg. demand for milk, electricity, wood etc. when price of
such commodity increases , then it is generally used for only very
essential uses, as a result , its demand falls.
CASE STUDY
TOPIC :-PRICE ELASTICITY OF DEMAND
OF COFFEE
COFFEE AS A COMMODITY

▪ An Empirical Assessment of Consumers’ Preferences for Coffee-

▪ Consider this graph of a survey done in the United States-

▪ This graph clearly portrays that

Coffee has a very high demand
and consumers love to consume it
over other beverages.
WHY COFFEE HAS SUCH A HIGH
DEMAND ?

▪ Coffee plays an integral role in many of our morning routines or social

calendars, which is due to global coffee outlets like Starbucks etc.,
which have revolutionized coffee’s need and CONSUMPTION
HABITS in our lives. Moreover, Coffee demand is also shaped by its
addictive taste characteristics, and health benefits such as burning fat
and boosting physical performance.
▪ These make coffee something of a NECESSITY – a good for which
people are relatively willing to sustain an increase in the price and are
relatively reluctant to decrease its consumption. Moreover, consumers
are not willing to SUBSTITUTE coffee with other beverages like tea
etc.
▪ Hence, Coffee has a very low price-elasticity of-demand i.e., it has
an inelastic demand.

▪ In fact, the elasticity of coffee demand is only about 0.3; that is, a 10%
rise in the price of coffee leads to a decline of about 3% in the quantity
of coffee consumed.
 COFFEE AS AN INDUSTRY

▪ PRICE ELASTICITY OF STARBUCKS COFFEE

▪ Coffee Shop Industry is an Oligopoly with Starbucks being a part of
one of a few large firms dominating the market for coffee and
breakfast, competing with McDonald's, Dunkin Donuts and Costa
Coffee.
▪ Starbucks has 40% market share in the coffee industry as of October
2019, and hence it has relatively elastic demand for its products,
because a little change in pricing will lead to greater change in demand
of its products, as per the characteristics of an oligopoly market.
Hence, we can
conclude that
coffee as a
commodity has
inelastic demand,
but demand of
coffee shop
industry is
relatively elastic
because of intense
competition in the
market.