Maharashtra Board Class 12 Economics Chapter 3B Elasticity of Demand PDF Download

Elasticity Of Demand

Introduction

In the previous chapter you have already studied the law of demand which shows the inverse relationship between quantity demanded and price of a commodity. The law of demand does not explain the extent of a change in demand due to a change in the price. Thus, law of demand fails to explain the quantitative relationship between price and quantity demanded. Therefore, Prof. Alfred Marshall explained the concept of elasticity of demand.

Concept Of Elasticity Of Demand

The term elasticity indicates responsiveness of one variable to a change in the other variable. Elasticity of demand refers to the degree of responsiveness of quantity demanded to a change in its price or any other factor.

According to Prof. Marshall, "Elasticity of demand is great or small according to the amount demanded which rises much or little for a given fall in price and quantity demanded falls much or little for a given rise in price."

It is clear from the above definition that elasticity of demand is a technical term which describes the responsiveness of change in quantity demanded to fall or rise in its price. In other words, it is the ratio of percentage change in quantity demanded of a commodity to a percentage change in price.

Teacher's Note

Elasticity of demand helps us understand how people change their buying when price changes. For example, if the price of tea increases, people may buy less tea and switch to coffee instead.

Exam Trick

Remember: Elasticity means "How much demand changes when price changes." Think of a rubber band - if it stretches a lot, it is elastic. If demand changes a lot, elasticity is high.

Points To Remember

Elasticity shows how much quantity demanded changes when price changes.
It is measured in percentage terms, not in absolute numbers.
Higher elasticity means demand is more sensitive to price changes.

Types Of Elasticity Of Demand

1) Income elasticity

2) Cross elasticity

3) Price elasticity

1) Income Elasticity

It refers to the degree of responsiveness of a change in quantity demanded to a change in the income only, other factors including price remain unchanged. It is expressed as:

\[E_y = \frac{\text{Percentage change in Qty. Demanded}}{\text{Percentage change in Income}}\]

Symbolically,

\[E_y = \frac{\% \triangle Q}{\% \triangle Y} = \frac{\triangle Q}{Q} \div \frac{\triangle Y}{Y} = \frac{\triangle Q}{Q} \times \frac{Y}{\triangle Y}\]

Where,

\(\triangle\) = Represents change

Q = Original demand

Y = Original income

\(\triangle Q\) = Change in quantity demanded

\(\triangle Y\) = Change in income of a consumer

You Should Know

Positive income elasticity: Normal goods for which demand increases with increase in income.

Negative income elasticity: Inferior goods for which demand decreases with increase in income of consumer.

Zero income elasticity: Necessary goods for which demand remains constant with increase in income of the consumer.

Teacher's Note

Income elasticity helps us see which goods are luxuries and which are necessities. When your family gets more money, you buy more ice cream but maybe the same amount of rice.

Exam Trick

Remember: Normal goods have positive income elasticity. When income goes up, demand goes up. Inferior goods have negative elasticity - when income goes up, demand goes down.

Points To Remember

Normal goods demand increases when income increases.
Inferior goods demand decreases when income increases.
Necessary goods demand stays same even when income changes.

2) Cross Elasticity

It refers to a change in quantity demanded of one commodity due to a change in the price of other commodity. (Complementary goods or substitutes)

\[E_c = \frac{\text{Percentage change in Qty. demanded of A}}{\text{Percentage change in Price of B}}\]

(A = Original commodity, B = Other commodity)

Symbolically,

\[E_c = \frac{\% \triangle Q_A}{\% \triangle P_B} = \frac{\triangle Q_A}{Q_A} \div \frac{\triangle P_B}{P_B} = \frac{\triangle Q_A}{Q_A} \times \frac{P_B}{\triangle P_B}\]

Where,

\(Q_A\) = Original quantity demanded of commodity A

\(\triangle Q_A\) = Change in quantity demanded of commodity A

\(P_B\) = Original price of commodity B

\(\triangle P_B\) = Change in price of commodity B

You Should Know

Positive cross elasticity: Substitute goods. Example, tea and coffee.

Negative cross elasticity: Complementary goods. Example, tea and sugar.

Zero cross elasticity: Non-related goods. Example, tea and books.

Teacher's Note

Cross elasticity shows how goods are related. If tea price goes up and people buy more coffee, they are substitutes. If tea price goes up and people buy less sugar, they are complements.

Exam Trick

Remember: Substitutes have positive cross elasticity (when one price goes up, demand for other goes up). Complements have negative cross elasticity (when one price goes up, demand for other goes down).

Points To Remember

Substitutes are goods that can replace each other like tea and coffee.
Complements are goods used together like tea and sugar.
Non-related goods have zero cross elasticity.

3) Price Elasticity

According to Prof. Alfred Marshall, price elasticity of demand is a ratio of proportionate change in the quantity demanded of a commodity to a given proportionate change in its price.

\[E_d = \frac{\text{Percentage change in Quantity Demanded}}{\text{Percentage change in Price}}\]

Symbolically,

\[E_d = \frac{\% \triangle Q}{\% \triangle P}\]

\[E_d = \frac{\triangle Q}{Q} \div \frac{\triangle P}{P}\]

\[E_d = \frac{\triangle Q}{Q} \times \frac{P}{\triangle P}\]

Where,

Q = Original quantity demanded

\(\triangle Q\) = Difference between the new quantity and original quantity demanded

P = Original price

\(\triangle P\) = Difference between new price and original price

Types Of Price Elasticity Of Demand

1) Perfectly Elastic Demand (Ed = ∞)

When a slight or zero change in the price brings about an infinite change in the quantity demanded of that commodity, it is called perfectly elastic demand. It is only a theoretical concept. For example, 10% fall in price may lead to an infinite rise in demand.

\[E_d = \frac{\text{Percentage change in Quantity Demanded}}{\text{Percentage change in Price}} = \infty\]

\[E_d = \infty\]

In figure, the demand curve is a horizontal line parallel to the X axis indicating perfectly elastic demand.

2) Perfectly Inelastic Demand (Ed = 0)

When a percentage change in price has no effect on the quantity demanded of a commodity it is called perfectly inelastic demand. For example, 20% fall in price will have no effect on quantity demanded.

\[E_d = \frac{\% \triangle Q}{\% \triangle P}\]

\[E_d = \frac{0}{20} = 0\]

\[E_d = 0\]

In practice, such a situation rarely occurs. For example, demand for salt, milk.

Teacher's Note

Price elasticity of demand measures how demand changes when price changes. If people buy the same amount no matter what the price is, demand is inelastic, like for essential medicines.

Exam Trick

Remember: Ed = 0 means perfectly inelastic (no change in demand no matter what price does). Ed = ∞ means perfectly elastic (tiny price change causes huge demand change). Most real goods are somewhere in between.

Points To Remember

Ed = 0 means demand does not change when price changes.
Ed = ∞ means demand changes infinitely with tiny price change.
Ed = 1 means demand changes proportionately with price change.

3) Unitary Elastic Demand (Ed = 1)

When a percentage change in price leads to a proportionate change in quantity demanded then demand is said to be unitary elastic. For example, 50% fall in price of a commodity leads to 50% rise in quantity demanded.

\[E_d = \frac{\% \triangle Q}{\% \triangle P} = \frac{50}{50} = 1 \therefore E_d = 1\]

When price falls from OP to OP₁ (50%), demand rises from OQ to OQ₁ (50%). Therefore, the slope of the demand curve is a rectangular hyperbola.

4) Relatively Elastic Demand (Ed > 1)

When a percentage change in price leads to more than proportionate change in quantity demanded, the demand is said to be relatively elastic. For example, 50% fall in price leads to 100% rise in quantity demanded.

\[E_d = \frac{\% \triangle Q}{\% \triangle P}\]

\[E_d = \frac{100}{50} \therefore E_d = 2\]

\[E_d > 1\]

When price falls from OP to OP₁ (50%), demand rises from OQ to OQ₁ (100%). Therefore, the demand curve has a flatter slope.

5) Relatively Inelastic Demand (Ed < 1)

When a percentage change in price leads to less than proportionate change in the quantity demanded, demand is said to be relatively inelastic. For example, 50% fall in price leads to 25% rise in quantity demanded.

\[E_d = \frac{\% \triangle Q}{\% \triangle P} = \frac{25}{50} = 0.5\]

\[E_d = 0.5 \therefore E_d < 1\]

When price falls from OP to OP₁ (50%), demand rises from OQ to OQ₁ (25%). Therefore, the demand curve has a steeper slope.

Teacher's Note

Price elasticity tells us how sensitive buyers are to price changes. Essential items like salt have low elasticity. Luxury items like cars have high elasticity.

Exam Trick

Remember: If quantity change percentage is BIGGER than price change percentage, then Ed > 1 (elastic). If quantity change is SMALLER than price change, then Ed < 1 (inelastic).

Points To Remember

Ed = 1 is unitary elastic - demand and price change by same percentage.
Ed > 1 is relatively elastic - demand changes more than price.
Ed < 1 is relatively inelastic - demand changes less than price.

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