Demand Elasticities

Dr.Ganesan
VIT Business School

Dr.PGS\VIT-BS\EAM\Demand El
• Introduction
– a measure of the responsiveness / sensitiveness
of one variable to change in some other
determinants of demand
• Kinds of Elasticities
– Price Elasticity of Demand
– Income Elasticity of Demand
– Cross Elasticity of Demand
– Promotional Elasticity of Demand

Dr.PGS\VIT-BS\EAM\Demand El
 Introduction
• The firm needs to know the effect of changes in
any of the independent variables in the demand
function on the quantity demanded
• Variables
– Under the control of management: Price,
advertising, product quality, and customer service
– Other variables are not under the control of
management: income, price of competitor’s
products, and expectations of consumers regarding
future prices

Dr.PGS\VIT-BS\EAM\Demand El
 Price Elasticity of Demand
• Price elasticity of demand is the percentage change in
quantity demanded given a percent change in the price.

• It is a measure of how much the quantity demanded of a

good responds to a change in the price of that good.

% ∆D
EDP = , ceteris paribus
% ∆P

Dr.PGS\VIT-BS\EAM\Demand El
 Measures of Price Elasticity
• Arc Elasticity: the elasticity of demand
between two finite points of demand curve
(𝑸 𝟐 −𝑸 𝟏)/(𝑸 𝟐+𝑸 𝟏)
ep=
(𝑷 𝟐 − 𝑷 𝟏)/(𝑷 𝟐+𝑷 𝟏)

Price A
∆Q P2 + P1
B ED = .
∆P Q2 + Q1

Dr.PGS\VIT-BS\EAM\Demand El
Qty. of Demand
Calculate price elasticity between an original
price of Rs.19 and a new price Rs.18
Price (Rs. / Unit) Quantity Sold, QD
20 12
19 14
18 16
17 18
16 20
12 28
11 30
Dr.PGS\VIT-BS\EAM\Demand El
 (𝑸 𝟐 −𝑸 𝟏)/(𝑸 𝟐+𝑸 𝟏)
ep=
(𝑷 𝟐 − 𝑷 𝟏)/(𝑷 𝟐+𝑷 𝟏)

(𝟏𝟖 −𝟏𝟐)/ (𝟏𝟖 +𝟏𝟐)

ep=
(𝟏𝟕 −𝟐𝟎)/ (𝟏𝟕 +𝟐𝟎)

(𝟔)/(𝟑𝟎)
ep=
(−𝟑)/(𝟑𝟕)

.𝟐
ep=
− 𝟎 .𝟎𝟖

ep= - 0.49

Dr.PGS\VIT-BS\EAM\Demand El
• Point Elasticity: elasticity at a point on the demand curve which
limiting the value of the elasticity as finite price interval tends to a
point OR elasticity is computed over a discrete range of the
demand curve or schedule

∂QD P
Price .A.B ep =
∂P
*
QD

Dr.PGS\VIT-BS\EAM\Demand El
Qty. of Demand
 ∂QD P
ep = *
∂P QD

2 17
ep = *
-1 18

ep = -2 * .94

ep = -1.88

Dr.PGS\VIT-BS\EAM\Demand El
Types of Price Elasticity
• Perfectly Inelastic
– Quantity demanded does not respond to price
changes.
• Perfectly Elastic
– Quantity demanded changes infinitely with any
change in price.

• Unit Elastic

– Quantity demanded changes by the same

percentage as the price.

Dr.PGS\VIT-BS\EAM\Demand El
 ep=0
Perfectly elastic Perfectly inelastic
ep=α

Unitary elastic

Price X ep=1

Qty. of Demand X
Dr.PGS\VIT-BS\EAM\Demand El
• Relatively Elastic
– Quantity demanded changes morethan
change in price.

• Relatively Inelastic
– Quantity demanded Changes less than
the price changes.

Dr.PGS\VIT-BS\EAM\Demand El
 Relatively elastic
20
ep= - 1.41
Price X 10
Ep>1

5 35

Qty. of Demand X

Relatively inelastic
20
Price X 10
ep= - 0.75
ep<1
5 15
Qty. of Demand X
Dr.PGS\VIT-BS\EAM\Demand El
Price Quantity Dd
12 30 =(10/-1)*(12/30)
11 40 = -4
10 50
9 60
8 70
7 80
=(50-30) / (50+30) / (10-12) / (10+12)
6 90
= -2.75
5 100
4 110

Dr.PGS\VIT-BS\EAM\Demand El
 Determinants of ep
• The number and closeness of the substitutes
– Greater the number ~ high elastic
• The share of the commodity in buyers’ budget
– Smaller the amount ~ inelastic
• Nature of the commodity
– Necessities ~ inelastic; Luxuries ~ elastic
• Number of uses a commodity can be put to
– Larger the use ~ greater the elasticity
• Habit forming characteristic
– Habit-forming ~ inelastic
• Time period
– Demand is more elastic in the long run than in the short run

Dr.PGS\VIT-BS\EAM\Demand El
Income Elasticity - Types of Goods
• Normal Goods
• Inferior Goods
– Higher income raises the quantity demanded for normal
goods but lowers the quantity demanded for inferior
goods.
• Goods consumers regard as necessities tend to be
income inelastic Examples include food, fuel,
clothing, utilities, and medical services.
• Goods consumers regard as luxuries tend to be
income elastic. Examples include sports cars,
furs, and expensive foods.

Dr.PGS\VIT BS\EAM\ed
Income Elasticity of Demand

• Income elasticity of demand measures how much

the quantity demanded of a good responds to a
change in consumers’ income.

• It is computed as the percentage change in the

quantity demanded divided by the percentage
change in income.

Dr.PGS\VIT-BS\EAM\Demand El
Computing Income Elasticity

Percentage Change in Qty. Dd. of X

Income Elasticity (ey) =
Percentage Change in Income

(Q2-Q1) / (Q2+Q1)
Income Elasticity (ey) =
(Y2-Y1) / (Y2+Y1)

Dr.PGS\VIT BS\EAM\ed
 Types of Income Elasticity

• High Income Elasticity

Cy
(ey>1)
– implies that quantity
demanded of good x Dx
increases by a larger
percentage than the
income of the
consumer
– e.g. Services &
Education
Dx
Dr.PGS\VIT BS\EAM\ed
• Unitary Income Elasticity
Cy
(ey=1)
– percentage change in the
quantity demanded of Dx
good x is equal to the
percentage change in y2
money income of the
consumer y1
– e.g., Clothing

D1 D2 Dx
Dr.PGS\VIT BS\EAM\ed
• Low Income Elasticity
Cy
(ey<1)
– income elasticity is low if
the relative change in Dx
quantity demanded is
less than the relative y2
change in money income
of the consumer
– e.g., food &
housing
D2 Dx
Dr.PGS\VIT BS\EAM\ed
• Zero Income Elasticity
Cy
(ey=0) Dx
– a change in income will
have no effect on the
quantity demanded
– e.g., salt

Dx
Dr.PGS\VIT BS\EAM\ed
 Cy

• Negative Income Elasticity

(ey= -ve)
– less is bought at higher
incomes and more is
bought at lower income Dx
– e.g., Inferior goods

Dx
 Income elasticity Vs Income sensitivity &
Income elasticity Vs Propensity to Consume

• ey • Income Sensitivity
– Changes in physical units – Changes in rupee
purchased due to change expenditure due to change
in income in income

• Propensity to Consumer
– Changes in consumption
expenditure of a
household due to change
in household income
Dr.PGS\VIT-BS\EAM\Demand El
Where do we use ey in business?

• Planning for firm’s growth

– ey is >1, sales - grow more than proportionately ~~
growth is high
– ey is <1, sales – grow less than proportionately ~~
growth is low
• Forecasting demand
• Formulating marketing strategy

Dr.PGS\VIT-BS\EAM\Demand El
Cross Elasticity of Demand

• Cross elasticity of demand measures how

much the quantity demanded of a good
responds to a change in price of other
commodity.
• It is computed as the percentage change in
the quantity demanded divided by the
percentage change in price of other
commodity.

Dr.PGS\VIT-BS\EAM\Demand El
Computing Cross Elasticity

Percentage Change in Qty. Dd. of X

Cross Elasticity (ec) =
Percentage Change in Price of Z

(Q2-Q1) / (Q2+Q1)
Cross Elasticity (ec) =
(Z2-Z1) / (Z2+Z1)

Dr.PGS\VIT-BS\EAM\Demand El
Cross Elasticity - Types of Goods

• Substitute Goods: ec= +ve

• Complementary Goods: ec= -ve

Dr.PGS\VIT-BS\EAM\Demand El
Promotional (Advertising) Elasticity of Demand

• Promotional elasticity of demand

measures how much the quantity
demanded of a good responds to a change
in promotional expenditure / ad
expenditure.
• It is computed as the percentage change in
the quantity demanded divided by the
percentage change in promotional and
advertising expenditure on the commodity.
Dr.PGS\VIT-BS\EAM\Demand El
 Computing Promotional / advertising
Elasticity

Percentage Change in Qty. Dd. of X

Promotional Elasticity (ea) =
Percentage Change in Promotional Exp.

(Q2-Q1) / (Q2+Q1)
Promotional Elasticity (ea) =
(A2-A1) / (A2+A1)

Dr.PGS\VIT-BS\EAM\Demand El
 Factors affecting ea
• Size of product & market
– ea differ – new and old products
– ea differ – established market and new market
–
• Effect of advertising in terms of response time from
customers
– Durable – quick response
– Non-durable – late response
• Influence of advertising by the competitors

Dr.PGS\VIT-BS\EAM\Demand El
 Theoretical and Practical Implications of e d
• Level of output and price
– Except perfect market firm, all firm / seller aware about the
change in price affects the change Qd
– ep<1, higher price can be charged
– Monopoly firm – price discrimination
• Fixation of price for factors of production
– ep<1, higher price for the factors
• Government Policies
– Output control
– Public Utilities – owned and operated by the government
– Taxation policy - ed – how much burden of additional taxation
will be borne by whom
• Demand Forecasting Dr.PGS\VIT-BS\EAM\Demand El