MCom I Semester Managerial Economics Elasticity Demand Study Material notes

MCom I Semester Managerial Elasticity Demand Economics Study Material notes: Meaning and Definition of Elasticity of Demand Various Concepts of Elasticity of Demand Types of Elasticity of Demand Methods of Measurement of Price Elasticity of Demand Determination of Elasticity od Demand or Factors Affecting Elasticity of Demand Importance and Uses of the Concept of Elasticity of Demand Distinction Between Law of Demand and Elasticity of demand

MCom I Semester Analysis Statistical Quality Control Study Material Notes

ELASTICITY OF DEMAND

MEANING AND DEFINITION OF ELASTICITY OF DEMAND

The elasticity of demand is the measurement of change in the quantity demanded of a commodity in response to a certain change in its price. The term *Elasticity of Demand’ has been defined as under:

1. “The elasticity (or responsiveness) of demand in a market is great or small according to as the amount demanded increases much or little for a given fall in price and diminishes much or little for a given rise in price.”

-Prof Marshall

2. “Elasticity of demand is a measure of the responsiveness of quantity demanded to a change in price.”

-Prof. Eastham

3. This (i.e., Elasticity of demand) is a concept devised to indicate the degree of responsiveness of Q demand to changes in market P. It depends primarily on percentage changed and is independent of units used to measure Q and P.

–Prof Samuelson Thus, the elasticity of demand is the ratio of percentage change in the quantity demanded to a percentage change in the price of a commodity. It measures the change in the demand of a commodity in response to a given change in its price.

VARIOUS CONCEPTS OF ELASTICITY OF DEMAND

(1) Price Elasticity of Demand. Price elasticity of demand expresses the relationship between a change in the quantity demanded of a commodity and a proportionate change in its price. While calculating price elasticity of demand, the income of consumers, their tastes and habits, and prices of all the related commodities are taken to be constant. According to Mrs. John Robinson, “Elasticity of demand is the proportionate change in quantity demanded in response to a small change in price, divided by the proportionate change in price.” Price elasticity of demand is so common form of elasticity of demand that when we say ‘Elasticity of Demand’ only, we mean to say, Price Elasticity of Demand’. It can be presented as under:

DETERMINANTS OF ELASTICITY OF DEMAND OR FACTORS AFFECTING ELASTICITY OF DEMAND

(1) Nature of Commodity. (i) Demand of the commodities of necessities is generally inelastic. (ii) Demand of the commodities of comforts is generally elastic. (iii) Demand of the commodities of luxuries is generally highly elastic,

(2) Substitute Goods. (i) If close substitutes of a commodity are available in the market, demand of such commodity will be elastic. (ii) Demand of a commodity for which no close substitutes are available, will be inelastic.

(3) Different Uses of Commodity. (i) If a commodity can be put to several uses, its demand will be elastic. (ii) If a commodity can be used only for a few purposes, its demand will be less elastic or inelastic.

(4) Price of Commodity. (i) Commodities which are priced very high or very low, have a relatively inelastic demand. Demand of low priced goods also tends to be inelastic, such as the demand of salt, match-box etc. Demand of goods which are moderately priced is generally elastic because such goods are purchased by middle class people.

(5) Effect of Nature and Habits of Consumers. Demand of commodities of habit and a particular brand is generally inelastic because a consumer can agree to pay higher price. Same is the case about the goods of a particular brand also.

(6) Distribution of Wealth. According to Prof. Taussig, if the distribution of wealth is unequal in the society, the demand of commodities will be less elastic. The distribution of wealth in a society is equal, demand of most of the commodities will be elastic.

(7) Share of a Commodity in a Consumer’s Budget. If a considerable part of the income of a consumer is spent on a commodity, demand of such commodity will be highly elastic. If only a fraction of the income of a consumer is spent on a commodity, demand of such commodity will be less elastic because a change in the price of such commodity will not disturb the budget of consumer.

(8) Time Effect. According to Prof. Marshall demand of the commodities is inelastic in short run, because in short run, substitution of one commodity by another is not very easy. In long run, the consumers may start to use substitute goods and hence the demand of almost all commodities tends to be elastic.

IMPORTANCE AND USES OF THE CONCEPT OF ELASTICITY OF DEMAND

In the words of Prof. Keynes, “Greatest contribution of Marshall to economics is the elasticity of demand. Importance and uses of elasticity of demand may be explained as under:

(1) In the Theory of Price Determination :

(i) Under the Conditions of Equilibrium. A firm is said to be in the state of equilibrium when its marginal revenue and marginal cost are equal. Marginal revenue depends upon elasticity of demand. Every producer has to consider elasticity of demand of a commodity is high its price should be low and vice-versa.

(ii) Under the Conditions of Monopoly. A monopolist would keep low price for the commodities having elastic demand so that they may earn maximum profit by taking maximum sales. He would like to fix high price for the commodities having inelastic demand.

(iii) Under Discriminating Monopoly. A monopolist will fix highr price in a market in which elasticity of demand is low so that he may obtain maximum sales revenue. Lower price will have to be fixed for the markets in which the elasticity of demand is more.

(2) In the Theory of Distribution. Concept of elasticity of demand influences the determination of reward for the factors of production. Producer pays high reward for the factors, the demand of which is inelastic and less reward for the factors, the demand of which is elastic.

(3) Significance for Government :

(i) Helpful in the Determination of Taxation Policy. Less taxes should be imposed on the commodities, the demand of which in inelastic and more taxes on the commodities, the demand of which is in elastic.

(ii) Helpful in Studying the incidence of Tax. If demand for a commodity is inelastic, producers will shift the burden of taxes on consumers. If demand for a commodity is elastic, burden of taxes will be borne by producers or sellers.

(iii) Helpful in the Formulation of Economic Policies. Government should have complete information in this regard so that it may control business cycles, remove inflationary or deflationary gaps and direct the economy from one line of production to another so that maximum utilisation of resources may be assured.

(iv) Helpful in the Determination of Public Utilities. Industries, the products of which have inelastic demand, should be declared public utility. Industries producing essential products like water, electricity, gas, transportation etc. should also be takenover by government. Industries whose products have elastic demand, should be left for private sector.

(4) Importance in International Trade. If the demand of goods of our country is inelastic in foreign countries, we can get better prices for our products. Similarly, if the demand of goods that we import is inelastic in our country, we will have to pay higher prices for them.

(5) Importance in the Allocation of Resources. More resources are allocated for the production of those commodities, demand of which is inelastic because it will fetch maximum revenue.

(6) It Explains the Paradox of Poverty Amidst Plenty. Concept of elasticity of demand is so important that the lack of its knowledge may cause poverty amidst. plenty. Example : A farmer gets bumper crop of a commodity, the demand of which is inelastic and the commodity is perishable. It may bring disaster instead of prosperity because the farmer will get low price of his crop for two reasons: (i) Increased production lowers the price. (ii) He cannot store the product because the commodity is perishable.

Elasticity Demand Study Material