Problem

• When the price of Walnut is Rs 1200/kg the

demand was 16,000 kg and supply was 8000
kg. As price increased to Rs 1800/kg the
demand decreased to 4000 kg and supply
increased to 12000 kg
• Construct linear demand and supply curve
and find out the equilibrium price and
quantity.
 Problem
• Demand for Oil is Q = 18- 3P
• Supply of Oil Q = -6+ 9 P
• Find equilibrium price and quantity

• Supply of Gas Q= 140+ 4 Pg + 0.5 Po

• Demand for Gas Q= -3 Pg + 14.5 Po
• Po is Rs 30
Elasticity of Demand and Supply
• When the price of Walnut was Rs 1200/kg the
demand was 16,000 kg per week in a market. As
price increased to Rs 1800/kg the demand
decreased to 4000 kg.
• When Price of banana was Rs 3000/qtl the demand
in that market was 120 qtl when the price increased
to Rs 4000/qtl the demand decreased to 60 qtl.
• Can we compare sensitivity of demand to prices of
these two commodities?
 Unit-free Measure of Responsiveness
• (%Q/% P) = (Q/Q)/(P/P)
• Ep =(Q/ P).(P/Q)
• Elasticity is a measure of the responsiveness of one variable
to changes in another variable.
• Elasticity is a percentage relationship: percentage change in
one variable resulting from one percent change in the other
• Price Elasticity of Demand: Percentage change in the
quantity demanded of a good resulting from a one percent
change in price
• Coefficient of Elasticity = Percentage change in A/
Percentage change in B
 Demand Function for Good X
QX = a0 + a1PX + a2N + a3I + a4PY + a5T
QX = 160 - 10PX + 2N + 0.5I + 2PY + T
Demand Curve for Good X
Given N = 58, I = 36, PY = 12, T = 112
Q = 430 - 10P
 Linear Demand Function
QX = a0 + a1PX + a2N + a3I + a4PY + a5T

PX
Intercept:
a0 + a2N + a3I + a4PY + a5T

Slope:
QX/PX = a1

QX
Linear Demand Function Example 2
Q = 600 – 100P
Inverse Demand Curve
P = 6 – 0.01Q
Total and Marginal Revenue Functions
TR = 6Q – 0.01Q2
MR = 6 – 0.02Q
 -

Source: R. F. Brooker
Source: R. F. Brooker
 -

Source: R. F. Brooker
 Extent of Elasticity
• Inelastic Demand: Elasticity less than one. Percentage change in
consumers purchase quantity is less than percentage change in price.
• Completely Inelastic Demand (Perfect Inelasticity): Consumer will buy
a fixed quantity of a good regardless of the price
• Elastic Demand: Elasticity greater than one. Percentage change in
consumers purchase quantity is more than percentage change in
price.
• Infinitely Elastic Demand (Perfect elasticity): Consumers buy as much
of good as they can get at a single price, but for any higher price the
quantity demanded drops to zero
• Unitary Elastic: Elasticity equal to one. Percentage change in
consumers purchase quantity equal to percentage change in price
Source: R. F. Brooker
Revenue and Ep
 Revenue and Ep
Elasticity Effect of Effect of Price
Price Decrease on
Increase on Revenue
Revenue
│Ep│<1 Revenue Revenue
Relative InElasticity Increases Decreases
│Ep│=1 No Change No Change in
Unitary elasticity in Revenue Revenue
│EP│>1 Revenue Revenue
Relative Elasticity decreases increases
 Total Revenue Test
• If the demand is elastic, an increase (decrease) in
price will lead to a decrease (increase) in total
revenue.
• If demand is inelastic, an increase (decrease) in
price will lead to an increase (decrease) in total
revenue.
• Finally, total revenue is maximized at the point
where demand is unitary elastic.
• Managerial decision: whether to cut in price?
 Demand Curve Faced by a Firm Depends
on Market Structure
• Market demand curve
• Imperfect competition
– Firm’s demand curve has a negative slope
– Monopoly - same as market demand
– Oligopoly
– Monopolistic Competition
• Perfect Competition
– Firm is a price taker
– Firm’s demand curve is horizontal
Source: R. F. Brooker
 Price Elasticity of Demand
QX = a0 + a1PX + a2N + a3I + a4PY + a5T

Point Definition Q / Q Q P
EP   
P / P P Q

P
Linear Function EP  a1 
Q
Price Elasticity of Demand

Q2  Q1 P2  P1
Arc Definition EP  
P2  P1 Q2  Q1
Determinants of Price Elasticity of Demand

The demand for a commodity will be more price elastic

if:
• It has more close substitutes
• Proportion of total expenditure
• Durability of the product
– Possibility of postponing purchase
– Possibility of repair
• More time is available for buyers to adjust to a price
change
Demand Curve Faced by a Firm Depends on the
Type of Product
• Durable Goods
– Provide a stream of services over time
– Demand is volatile
• Nondurable Goods and Services
• Producers’ Goods
– Used in the production of other goods
– Demand is derived from demand for final goods or
services
Derived Demand Curve will be more inelastic

• The more essential is the component

• The inelastic is the demand curve for the final
product
• The smaller is the fraction of total cost going
to this component
• The more inelastic is the supply curve of
cooperating factors
 Income Elasticity of Demand
QX = a0 + a1PX + a2N + a3I + a4PY + a5T

Point Definition Q / Q Q I
EI   
I / I I Q

Linear Function I
EI  a3 
Q
Income Elasticity of Demand

Q2  Q1 I 2  I1
Arc Definition EI  
I 2  I1 Q2  Q1

Normal Good Inferior Good

EI  0 EI  0
 Income (Expenditure) elasticities of food

Cereals 0.514 0.424 0.312 -0.006 0.187

Pulses 0.993 0.895 0.793 0.580 0.716
Vegetables & fruits 0.759 0.785 0.811 0.839 0.817
Milk 2.342 2.018 1.773 1.556 1.640
Edible oils 0.935 0.876 0.817 0.695 0.772
Sugar 1.052 1.007 0.968 0.898 0.942
Other food commodities 0.840 0.872 0.895 0.894 0.887

Price elasticity of
Demand
Cereals -0.309 -0.242 -0.150 -0.127 -0.031
Pulses -0.710 -0.691 -0.661 -0.602 -0.635
Vegetables & fruits -0.893 -0.901 -0.908 -0.928 -0.917
Milk -0.820 -0.923 -0.999 -1.076 -1.035
Edible oils -0.476 -0.454 -0.415 -0.332 -0.377
Sugar -0.081 -0.083 -0.065 -0.036 -0.010
Other food commodities -1.301 -1.298 -1.285 -1.250 -1.259

Table 7. Income elasticities of food based on FCDS model

Food Income group

Very poor Moderately poor Non-poor lower Non-poor higher All

Rice 0.182 0.102 0.030 -0.025 0.024

Wheat 0.102 0.083 0.070 0.071 0.075
Coarse cereals -0.123 -0.154 -0.141 -0.095 -0.125
Pulses 0.578 0.423 0.279 0.105 0.219
Milk 0.862 0.694 0.539 0.276 0.429
Edible oils 0.703 0.537 0.375 0.156 0.297
Vegetables 0.693 0.518 0.370 0.174 0.259
Fruits 0.753 0.599 0.492 0.282 0.362
Meat, fish & eggs 1.034 0.900 0.799 0.531 0.669
Sugar 0.337 0.205 0.107 0.010 0.062
Other food commodities 1.160 1.003 0.911 0.638 0.748
Non-food commodities 2.403 2.421 2.321 1.819 1.993
 Short Run versus Long Run Elasticities
• Demand
– Price
• Non-durables: long run price elasticity is more than the short run
• Durables: long run price elasticity is less than the short run
– Income
• For most goods:long run income elasticity is larger than the short
run
• Durables: long run income elasticity is less than the short run
– Cyclical industries: Sales tend to magnify cyclical changes in gross
domestic products and national income.
• Petrol
– Ep = -0.11 -0.22 –0.32 –0.49 –0.82 –1.17
– EI = 0.07 0.13 0.20 0.32 0.54 0.78
• Automobile
– EP = -1.20 -0.93 -0.75 -0.55 -0.42 0.40
– EI = 3.2 2.33 1.88 1.38 1.02 1.00
Source: Robert F. Brooker
Source: Robert F. Brooker
 Cross-Price Elasticity of Demand
QX = a0 + a1PX + a2N + a3I + a4PY + a5T

Point Definition QX / QX QX PY

E XY   
PY / PY PY QX

Linear Function PY
E XY  a4 
QX
Cross-Price Elasticity of Demand

Arc Definition QX 2  QX 1 PY 2  PY 1
E XY  
PY 2  PY 1 QX 2  QX 1

Substitutes Complements

E XY  0 E XY  0
 Problems
• Supply of Gas Q= 140+ 4 Pg + 0.5 Po
• Demand for Gas Q= -4 Pg + 15 Po
• Po is Rs 40
• Cross Price elasticity at equilibrium?
Source: R. F. Brooker
Commodity Bread Poultry Vegetables Fruits Juices

Bread -.354 0.013 -.046 -.010 -.006

Poultry -.018 -.644 -.091 -.000 -.012

Vegetables -.086 -.049 -.724 -.029 -.001

Fruits -.092 -.023 -.087 -.712 -.046

Juices -.066 -.025 -.006 -.067 -1.011

Source: Robert F. Brooker
 Cross Price Elasticities
Raspuri Mallika Alphonso

Raspuri -3.07 1.56 0.01

Mallika 1.16 -3.01 0.14

Alphonso 0.18 0.09 -2.76

Price Elasticity for different brands of
wines in Italy
• Advertising Elasticity : Percentage change in
quantity relative to 1 percent change in
advertising expenses.
• Elasticity with respect to interest rates
 Policy Decision Making
An officer managing a public park is thinking of
increasing price in order to generate more
revenue. What information he/she should
collect/analyse to arrive at an appropriate
decision?
 Supply elasticity
• Price Elasticity of Supply: Percentage change
in quantity supplied resulting from a one
percent increase in price
• Point Elasticity of Demand: Price elasticity at a
particular point on the demand curve
• Arc Elasticity of Demand: Price elasticity
calculated over a range of prices
Price Elasticity of Supply of durables

SR LR

Primary 0.2 1.60

Supply
Secondary 0.48 0.31
Supply
Total 0.25 1.50
• Supply
– For most products long-run supply is much more
price elastic than short run supply – capacity
constraints
– For durables supply is more elastic in the short-
run – recycling; secondary supply
 Market Equilibrium

Price

D0 S0

P0

P1

Quantity
Q1 Q0 Q2
 Market Equilibrium

Price

D0 S0

P1

P0

Quantity
Q1 Q0 Q2
Market Equilibrium: Effect of Tax

Price
S1

D0
S0
P1

P0

Quantity
Q1 Q0
 Incidence of a Specific Tax
Price

S
Pb price
buyers pay
Tax =
$1.00 P0
PS price
producers
get

Q1 Q0 Quantity
 Incidence of a Specific Tax
• Four conditions that must be satisfied after
the tax is in place:
1. Quantity sold and buyer’s price, Pb, must be on
the demand curve
• Buyers only concerned with what they must pay
2. Quantity sold and seller’s price, PS, must be on
the supply curve
• Sellers only concerned with what they receive
 Incidence of a Specific Tax
• Four conditions that must be satisfied after
the tax is in place (cont.):
3. QD = QS
4. Difference between what consumers pay and
what buyers receive is the tax
• If we know the demand and supply curves as
well as the tax, we can solve for PB, PS, QD and
QS
 Incidence of a Specific Tax
• In the previous example, the tax was shared
almost equally by consumers and producers
• If demand is relatively inelastic, however,
burden of tax will fall mostly on buyers
– Cigarettes
• If supply is relatively inelastic, the burden of
tax will fall mostly on sellers
 Impact of Elasticities on Tax Burdens
Burden on Buyer Burden on Seller
Price D Price S

Pb

S
t Pb
P0 P0
PS
t
D
PS

Q1 Q0 Quantity Q1 Q0 Quantity
 The Impact of a Tax or Subsidy
• We can calculate the percentage of a tax
borne by consumers using pass-through
fraction
– ES/(ES - Ed)
– Tells fraction of tax “passed through” to
consumers through higher prices
– For example, when demand is perfectly inelastic
(Ed = 0), the pass-through fraction is 1 – consumers
bear 100% of tax
 The Effects of a Tax or Subsidy
• A subsidy can be analyzed in much the same
way as a tax
– Payment reducing the buyer’s price below the
seller’s price
• It can be treated as a negative tax
• The seller’s price exceeds the buyer’s price
• Quantity increases
Market Mechanism: Cob-Web Model

Price
S1
D1

P3
P1
P2

Quantity
Q2 Q1 Q3
Market Mechanism: Cob-Web Model

Price
S1
D1

P3
P1

P2

Quantity
Q2 Q1Q3
 Computer Use in India
• 25% growth between (2001/2 to 2006/7)
• But penetration (per thousand population) in India is low
– India 23
– China 79
– Brazil 139
– Russia 153
• Taxes 20.36%. In many other countries taxes are removed
India Units Value $M Price $
Des ktops Des ktops
2000 Q1 344,607 349 1013.15
Q2 404,182 384 949.47
Q3 476,896 436 913.79
Q4 468,485 431 920.83
2001 Q1 530,691 476 896.54
Q2 489,103 396 809.19
Q3 498,040 397 797.07
Q4 500,377 387 773.87
2002 Q1 520,564 413 793.36
Q2 513,306 389 758.63
Q3 544,552 405 743.77
Q4 563,106 419 744.23
2003 Q1 612,591 461 752.51
Q2 565,200 438 774.58
Q3 664,144 482 725.78
Q4 678,220 481 709.03
2004 Q1 771,984 540 698.86
Q2 757,642 531 700.52
Q3 825,085 571 691.56
Q4 878,000 619 705.29
2005 Q1 896,698 619 689.79
Q2 946,389 589 622.71
Q3 1,010,130 612 605.62
Q4 994,838 582 585.46
2006 Q1 1,091,214 678 621.00
Q2 1,033,018 650 628.98
Q3 1,163,420 723 621.45
Q4 1,129,872 716 633.54
2007 Q1 1,159,751 750 646.71
DDesktops
DNotebooks
PDesktops
DPCI URBANGDPGR PNotebook
3.42 0.085 1013 2518 27.68 5.8 3656
3.99 0.092 949.5 2528 27.72 5.4 3901
4.68 0.107 913.8 2506 27.76 6.2 3711
4.57 0.099 920.8 2481 27.79 3.4 3875
5.15 0.101 896.5 2504 27.85 1.5 3836
4.72 0.098 809.2 2568 27.91 4.5 3520
4.79 0.096 797.1 2498 27.96 5.3 3180
4.79 0.080 773.9 2471 28.01 6.3 2489
4.97 0.089 793.4 2485 28.10 6.7 2200
4.89 0.115 758.6 2516 28.21 5.1 2224
5.18 0.122 743.8 2459 28.32 5.5 2364
5.33 0.137 744.2 2442 28.35 2 2308
5.76 0.149 752.5 2452 28.31 3.7 2261
5.30 0.172 774.6 2574 28.42 5.5 2277
6.22 0.218 725.8 2549 28.53 8.9 2166
6.32 0.245 709 2532 28.57 11.3 2078
7.14 0.324 698.9 2527 28.53 7.9 1977
7.00 0.399 700.5 2637 28.64 7.9 2023
7.61 0.516 691.6 2573 28.75 6.7 1910
8.06 0.519 705.3 2557 28.78 7 1851
8.16 0.584 689.8 2550 28.72 8.6 1714
8.58 0.933 622.7 4235 28.77 8.5 1467
9.13 1.396 605.6 4144 28.83 8.4 1361
8.96 1.413 585.5 4066 28.88 7.5 1317
9.79 1.650 621 4006 28.94 9.3 1329
9.23 1.962 629 4260 28.99 8.9 1262
10.36 2.467 621.4 4197 29.05 9.2 1241
10.02 2.622 633.5 4135 29.10 9.2 1131
Regressing sales of desktops on its prices (in US dollars)
and per capita deflated income shows the following results
 
DDT = 10.98 – 0.11 DPT + 0.02 DPCI
(-5.95) (4.39)
 R-square =.934
 
Price elasticity of demand at mean level is 1.25
 Income elasticity of demand at mean level is 0.44
 
The result for the notebook is as follows
 
DNB =-149.29 – 0.15 PNB + 0.084 DPCI
(-1.74) (7.58)
R-square =.922
 
Price elasticity of demand at mean level is 0.58
 
Income elasticity of demand at mean level is 4.10
• D = 10.98 – 0.11 P + 0.02 PCI
• D=Demand for personal computers (in ‘00000)
• P= Price of personal computer (in $)
• PCI = Per capita income ($/year)
• Current level: PCI=400
• D = 18.98 – 0.11 P
 Regression Results (log form)
Desktop
Log Qd = 8.20 – 1. 40 Log DPd + 0.35 Log DPCY
(3.24) (-5.66) (2.86) 
R-Square = 0.89

Notebook
Log Qn = -12.96 –1.14 Log DPn + 2.52 Log DPCY
(-2.09) (-3.24) (5.51)
 R-square =.924