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Elasticity of Demand
and Supply
Prof. Rama Deshmukh
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Concept
Definition
4 types and
3 methods of measurement
Determinants of price elasticity
• 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
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)
Given the demand
schedule, calculate the e
Price
6
5
4
3
2
1
Qty
0
20
40
60
80
100
• When price change
from 5 to 3
• e=2
2) Point elasticity
method
E=∞
e>1
E=1
E<1
E=0
• 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.
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 < 1 what will happen to TR when P rises or
falls ?
increase
• If e >1 what will happen to TR when P rises or
falls?
decrease
Relation between AR, MR
and Price elasticity
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TR= PQ
AR= PQ/Q=P
MR= δTR/δQ
MR= P*
(δQ/δQ)+Q*(δP/δQ)=
P+Q*(δP/δQ)= P
{1+Q/P*δP/δQ}
• e= (P/Q)*(δQ/δP)
• MR= AR-(AR/IeI)
TR
AR
MR
• Let us consider the demand function
as Q=120-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 P=100, MR= 80
5 types of Price elasticity
of demand
1)
2)
3)
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.
Perfectly elastic and
inelastic demand
• e=infinity
• The demand
curve is parallel
to X axis
• e =0
• Demand curve is
parallel to Y
axis.
1) Price elasticity of demand =
(δQ/δP)* P/Q
2) Income elasticity of demand
3) Cross elasticity of demand
4) Promotional elasticity of demand
• The demand function for mutton for Ravi
is given as: Q= 5850-6Pm+2Pc+0.15Y
where Y=8000, Pm=125, Pc=70. Calculate
income elasticity and cross elasticity
• ey=(δQ/δY)*(Y/Q)
• Q= 5850-(6*125)+(2*70)+(0.15*8000)=
6440
• ey= 0.15*(8000/6440)= 0.186
Determinants of price
elasticity
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Nature of commodity
Availability of substitutes
Weightage in the consumption
Time factor in the adjustment of the
consumption pattern
• Range of commodity use
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.
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:- P&G 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 & G’s
• similar products like Ariel and Tide will increase.
Determinants of
promotional elasticity
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Level of total sales
Advertisement of the rival firms
Cumulative effect of the past advt.
Other factors
Quiz
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
Prices can be increased to
shift the excise duty to
consumer if the product
subjected to duty is -•
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In relatively inelastic demand
In relatively elastic supply
Perishable good
Widely used
Luxury item
How would you indicate
relatively elastic demand?
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E=0
E<1
E>1
E=1
A fall in the price of a
commodity leads to
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Shift in the demand
Fall in the demand
Rise in the consumer’s real income
Fall in the consumers real income
When the demand is elastic,
a price reduction -• Will increase total revenue
• Will decrease total revenue
• Will not affect total revenue
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
If the income elasticity of
demand is greater than
unity, the commodity is -•
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Necessity
Luxury
Normal good
Non-related good