FACTORS DETERMINING PRICE

ELASTICITY OF DEMAND
 Nature of the commodity : either the good is
a necessity, comfort or luxury
 Demand for necessity will be less elastic
 Demand for luxury will be more elastic
 Substitutes :
 Commodities having substitutes are more
elastic

 Variety of uses : demand for goods like milk,

coal , electricity is more elastic
 If price of coal falls, its demand for all
quarters will increase
 Demand for construction houses have elastic
demand , demand for goods like meals have
inelastic demand
 Range for prices : very high and very low
prices tend to be inelastic , middle range are
more elastic because a rise or fall in price
will affect the demand of a large number of
person
 Time factor : the shorter the time the lesser
will be the elasticity of demand , the longer
the time the higher will be elasticity of
demand

 Results in discovery of new products ,

substitutes , change in habits, consumer
adjustments to new products
 Durability of goods :
 When goods are durable like scooter, TV ,
car etc , the demand is inelastic
 Because people don't buy more when price
fall
 Classes of buyer : wealthy and well to do
people have inelastic demand , a change in
price will not affect much of the quantity
demanded

 People of middle class have more elastic

demand , a change in price will bring larger
change in demand
INCOME ELASTICITY OF DEMAND
 Income elasticity measures the
responsiveness of quantity demanded of a
commodity to changes in the income of a
consumer
 Measures the rate at which the quantity
bought changes, with the change in income
other things remaining the same
 E= percentage in quantity demanded /
percentage in income
KINDS OF INCOME ELASTICITY
 Positive income elasticity : (E>0)
 When the quantity demanded of a
commodity increases with the increase in
income , elasticity is said to be positive

 Valid for normal goods

 Negative income elasticity : (E<0)
 When the amount demand decreases with
the rise in income

 Valid for giffen or inferior goods

 Zero income elasticity : (E=0)

 When the demand for a commodity does not

respond to change in income

 Valid for goods which are very basic and

cheap – salt , sugar , newspaper etc
CROSS ELASTICITY OF DEMAND
 When the demand for a commodity changes
with the change in price of a related good

 The rate at which the quantity demanded of

commodity X changes with the change in the
price of commodity Y
 E XY= % change in the quantity demanded of
X/% change in the price of Y
TYPES OF CROSS ELASTICITY OF
DEMAND
 Positive cross elasticity :

 When increase in the price of one product

will result in the increase in the demand for
other good
 Substitutes goods have said to have positive
cross elasticity
 Negative cross elasticity :
 When increase in the price of one product
will result in fall in the demand for other

 Complementary goods
 Zero cross elasticity :

 When change in price of one product will

cause no change in the price of other
product

 Valid for independent goods/ unrelated

goods
IMPORTANCE OF ELASTICITY OF
DEMAND IN MANAGERIAL ECONOMICS
 Managerial use of price elasticity of demand
 Income elasticity

 Cross elasticity
USE OF PRICE ELASTICITY
 Determination of price under monopoly
 Basis of price determination
 Price determination of joint products
 Determination of wages (demand for lb is
elastic or inelastic , if dd is elastic strikes ,
lock outs will not help in raising wages )
 Advantage to finance minister
 Determination of price for public utilities
(electricity , post and telegraph , railways
etc )
 Distribution of burden of taxes
 International trade
IMPORTANCE OF INCOME
ELASTICITY
 Knowledge of nature of good : differentiate
between essential and non essential goods,
commodities with high elasticity are luxuries,
commodities of basic nature are for
necessities
 Helpful in business research :
 Helpful in calculating income sensitivity (%
change in rupee expenditure as a result of %
change in income )
 Importance in production planning :
elasticity help in calculating the demand and
supply elasticity's and hence helpful in
planning for production
IMPORTANCE OF CROSS
ELASTICITY
 Classification of commodities :
 Substitute goods : cross elasticity is positive
 Complementary goods : cross elasticity is
negative
 Independent goods :cross elasticity is zero
 Helpful to define industry : commodities who
have good substitutes available tend to have
higher cross elasticity, firms producing
substitutes will automatically tend to have
higher cross elasticity
ADVERTISING ELASTICITY OF
DEMAND
 AED is useful in determining the optimum
level of advertisement expenditure
 It is essential for competitive advantage
 AE is defined as the ratio of proportionate
change in sales to the proportionate change
in advertising expenditure
 eA= DS*A /DA*S
DEGREE OF ADVERTISEMENT
ELASTICITY
 E=0, when sales does not respond to increase
in expenditure
 E=infinity , when sales respond up to infinity
with a small change in expenditure
 E=1, when sales increases in same proportion
with increase in expenditure
 E = greater than unity , when sales increases
by a higher proportion than expenditure
 E= less than unity, when sales increases in
less proportionate manner
FACTORS AFFECTING
ADVERTISEMENT ELASTICITY
 The level of total sales

 Cumulative effect of past advertisement

 Advertisement by rival firms

 Other factors (nature of the product,
consumer income , taste and preferences
etc