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Elasticity of Demand and Supply

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Elasticity of Demand and Supply Prof. Rama Deshmukh Concept Definition 4 types and 3 methods of measurement Determinants of price elasticity Elasticity is degree of ... – PowerPoint PPT presentation

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Title: Elasticity of Demand and Supply


1
Elasticity of Demand and Supply
  • Prof. Rama Deshmukh

2
  • Concept
  • Definition
  • 4 types and
  • 3 methods of measurement
  • Determinants of price elasticity

3
  • Elasticity is degree of responsiveness
  • Concepts
  • 1) Price elasticity of demand
  • 2) Income elasticity of demand
  • 3) Cross elasticity of demand
  • 4) Promotional elasticity of demand

4
3 methods of measurement
  • 1 ) Percentage or proportionate method
  • e change in demand / change in price. The
    formula is e P/Q. d Q /d P
  • This formula is biased, therefore a better
    formula is e d Q / (Q1 Q2 / 2)
  • --------------------------
  • d P /( P1 P2 / 2)

5
Given the demand schedule, calculate the e
  • When price change from 5 to 3
  • e 2

Price Qty
6 0
5 20
4 40
3 60
2 80
1 100
6
2) Point elasticity method
  • On a linear demand curve e lower segment upon
    upper segment of a curve
  • On a non-linear demand curve first a tangent
    needs to be drawn before deciding value of e.

E8
egt1
E1
Elt1
E0
7
3) Total outlay method
  • Total revenue or outlay remains unchanged if e 1
    Reason if e 1 then d D would be same as d
    P and TR P.Q . IF price rises demand would
    contract proportionately keeping TR unaltered.
  • If e lt 1 what will happen to TR when P rises or
    falls ?
  • increase
  • If e gt1 what will happen to TR when P rises or
    falls?
  • decrease

8
Relation between AR, MR and Price elasticity
  • TR PQ
  • AR PQ/QP
  • MR dTR/dQ
  • MR P (dQ/dQ)Q(dP/dQ) PQ(dP/dQ) P
    1Q/PdP/dQ
  • e (P/Q)(dQ/dP)
  • MR AR-(AR/IeI)

TR
AR
MR
9
  • Let us consider the demand function as Q120-P.
    Estimate quantity when price is 120, 100, 60, 20.
    Also find the value of MR when P 100
  • TR (120-Q)Q 120Q-Q2
  • MR 120-2Q
  • When P100, MR 80

10
5 types of Price elasticity of demand
  • E 1 ,here demand curve is straight line or
    rectangular hyperbola.
  • A relatively elastic demand curve is to the right
    and flatter or gently falling.
  • Whereas relatively inelastic curve is steeply
    falling and to the left.

11
Perfectly elastic and inelastic demand
  • einfinity
  • The demand curve is parallel to X axis
  • e 0
  • Demand curve is parallel to Y axis.

12
  • 1) Price elasticity of demand (dQ/dP) P/Q
  • 2) Income elasticity of demand
  • 3) Cross elasticity of demand
  • 4) Promotional elasticity of demand

13
  • The demand function for mutton for Ravi is given
    as Q 5850-6Pm2Pc0.15Y where Y8000, Pm125,
    Pc70. Calculate income elasticity and cross
    elasticity
  • ey(dQ/dY)(Y/Q)
  • Q 5850-(6125)(270)(0.158000) 6440
  • ey 0.15(8000/6440) 0.186

14
Determinants of price elasticity
  • Nature of commodity
  • Availability of substitutes
  • Weightage in the consumption
  • Time factor in the adjustment of the consumption
    pattern
  • Range of commodity use

15
Cross Elasticity of Demand
  • Cross elasticity of demand is the ratio of
    percentage change in the quantity demanded
  • For one product to a percentage change in the
    price of another related product, other factors
    remaining constant.
  • If the two products are good substitutes, the
    value of cross elasticity will be positive.
  • If the two products are good complementary, the
    value of cross elasticity will be negative.

16
Application of cross elasticity of demand
  • The knowledge of cross elasticity of demand is
    very important in managerial decision making for
    developing an appropriate price strategy. Firms
    selling multiple products use cross elasticity of
    demand to analyze the effect of change in the
    price of on product to the demand of others.
  • Firms producing similar kinds of product and
    services operating in same industry having a
    positive cross elasticity of demand.
  • Eg- PG and HLL are having a positive cross
    elasticity
  • Of demand between each other in fabric and home
    care
  • products. Hence, if HLL plans to increase the
    price of
  • Surf, a washing detergent, the demand for P
    Gs
  • similar products like Ariel and Tide will
    increase.

17
Determinants of promotional elasticity
  • Level of total sales
  • Advertisement of the rival firms
  • Cumulative effect of the past advt.
  • Other factors

18
Quiz
19
The demand for the commodity is said to be
elastic if the total amount spent on the
commodity is -
  • Less when the price is low then when the price is
    high
  • Same whether the price is high or low
  • More when the price is low than when the price is
    high

20
Prices can be increased to shift the excise duty
to consumer if the product subjected to duty is --
  • In relatively inelastic demand
  • In relatively elastic supply
  • Perishable good
  • Widely used
  • Luxury item

21
How would you indicate relatively elastic demand?
  • E 0
  • E lt 1
  • E gt 1
  • E 1

22
A fall in the price of a commodity leads to
  • Shift in the demand
  • Fall in the demand
  • Rise in the consumers real income
  • Fall in the consumers real income

23
When the demand is elastic, a price reduction --
  • Will increase total revenue
  • Will decrease total revenue
  • Will not affect total revenue

24
Which of the following statements are true?
  • Elasticity of demand is determined by
    substitution possibilities
  • If the demand is inelastic, a change in the price
    will not affect the quantity sold
  • If total revenue falls when the price increases,
    demand is elastic

25
If the income elasticity of demand is greater
than unity, the commodity is --
  • Necessity
  • Luxury
  • Normal good
  • Non-related good
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