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Demand and Its elasticity


Demand
Meaning of Demand: Demand of commodity refers to the quantity of a commodity which a consumer is willing to buy at a given price, and time.
Demand Function: Demand Function is the functional relationship between demand and factors affecting demand.
Dx = f (Px, Po, Y, T, E)
Factors affecting Demand:-Following are the factors which affect the Demand.
1.       Price of Commodity: When the price of commodity rises demand of commodity will decrease and vice-versa.
2.       Price of other related commodity: Price of other commodity affect the demand of commodity in two ways:
a)      Substitute Goods:-In the case of substitute goods, the demand for a commodity X rises with a rise in the Price of commodity Y and vice versa.
Example- Tea and coffee
b)     Complementary Goods:-In case of complementary goods, the demand for a commodity X rises with the fall in the Price of commodity Y and vice versa.
Example: Car and Petrol, Ink and Pen,
3.      Income of Consumer: - When the Income of Consumer raises the demand of normal goods increases and if the income decreases the demand of normal good decreases. In case of Inferior good the demand will decrease with rise in income and increase with decrease in income.
4.      Taste and Preference: - If the taste and preference of consumer develop for a commodity the demand will rise.
5.         Expectation: - If the consumer expects that price in future will rise the demand                will rise and vice-versa.
6.         Population: - More population, more demand, less population less demand.
7.         Climate: - The demand of commodity changes according to the climate.

Types of demand-
  1. Individual demand - It refers to the quantities of a commodity that an individual consumer is willing to purchase at various price during a given period of time.
  2. Market demand – it refers to the total quantities of a commodity that the entire household are willing to buy at various prices during a given period of time.
  3. Ex ante demand – it refers to the amount of goods that consumer want to or willing to buy during a particular time period. It is also called a planned or desired amount of demand.
  4. Ex post demand – it refers to the amount of the goods that the consumer actually purchases during a specific period.
  5. Joint demand – It refers to the demand for two or more goods which are used jointly or demanded together.
  6. Derived demand – It refers to those commodities, which arises due to rise in the demand of some other commodity is called derived demand.
  7. Composite demand – demand for goods that have multiple uses is called composite demand.
  8. Inferior Goods: - These are the goods for which demand rises with decreases in income of consumer. In other words income effect is negative.
  9. Giffen Goods: - Those inferior goods whose income effect is negative but price effect is positive.
Law of Demand: - Other things are being equal, the demand for a good rises with a decrease in         price and decreases with increase in price.
P Increases = demand decrease and vice - versa
Tabular presentations:-
Price
Demand
05
200
10
150
20
100

Diagram

Change in Quantity demanded: - It is also called movement along a demand curve. Due to change in its own price, quantity of commodity changes. There are two type of change in quantity of Demand
(a)   Extension in Demand - price decrease = demand increases
(b)  Contraction in Demand –Price increase = demand decrease
Diagram
Change in Demand: - It is also called shift in demand curve. When quantity of commodity change due to change in factor other than price. It has two types-
a)  Increase in Demand        b)        Decrease in Demand
Diagram
Elasticity of Demand
The elasticity of demand measures the responsiveness of the quantity demanded due to change in price of the commodity.

Types of Elasticity of Demand

1.             Price Elasticity of Demand: The price elasticity of demand, commonly known as the elasticity of demand refers to the responsiveness and sensitiveness of demand for a product to the changes in its price. In other words, the price elasticity of demand is equal
To Numerically,
Formula:
Where, ΔQ = Q1 –Q0, ΔP = P1 – P0, Q1= New quantity, Q2= Original quantity, P1 = New price, P0 = Original price. 
The following are the main 
Proportionate or Percentage Method: - Under this method elasticity of demand is measured by the ratio of the percentage change in quantity demanded to the percentage in price.
Ed = Percentage change in Quantity Demanded
          Percentage change in Price
 Degrees of Price Elasticity of Demand:
    • Perfectly Elastic Demand
    •  Perfectly Inelastic Demand
·         Highly(Relative) Elastic Demand
    • Less than unit(Relatively) Inelastic Demand
    • Unitary Elastic Demand
Explanation:
Degrees of elasticity of Demand: - There is the different degree  of  elasticity of demand.
1. Perfectly elastic Demand: -When the demand for a commodity rises or falls to any extent, without any change in its price, the demand is said to be perfectly elastic.
Ed=∞     % change in price = 0 Demand curve is parallel to OX axis.
Diagram
2. Perfectly Inelastic Demand: - When the demand of a commodity does not change as a result of change in price, it is called perfectly inelastic demand. ed=0, % change in demand = 0
Diagram.
3. Unitary Elastic Demand: - When the percentage change in quantity is equal to percentage change in price it is called elastic demand. Ed=1
%    change in quantity = % change in price
Diagram
4.      Inelastic Demand: - When the percentage change in quantity is less then %change in price, it is called inelastic demand.
%    change in quantity < % change in price
Diagram
5.      Elastic Demand: - When the percentage change in quantity is greater than percentage change in price it is called elastic demand.
%    Change in quantity > % change in price
Diagram
2. Income Elasticity of Demand:
The income is the other factor that influences the demand for a product. Hence, the degree of responsiveness of a change in demand for a product due to the change in the income is known as income elasticity of demand. The formula to compute the income elasticity of demand is:
Formula
For most of the goods, the income elasticity of demand is greater than one indicating that with the change in income the demand will also change and that too in the same direction, i.e. more income means more demand and vice-versa.


Types of Income Elasticity of demand

1.       Positive income elasticity of demand (EY>0)

If there is direct relationship between income of the consumer and demand for the commodity, then income elasticity will be positive. That is, if the quantity demanded for a commodity increases with the rise in income of the consumer and vice versa, it is said to be positive income elasticity of demand. For example: as the income of consumer increases, they consume more of superior (luxurious) goods. On the contrary, as the income of consumer decreases, they consume less of luxurious goods.
Positive income elasticity can be further classified into three types:
(a) Income elasticity greater than unity (EY > 1)
If the percentage change in quantity demanded for a commodity is greater than percentage change in income of the consumer, it is said to be income greater than unity. For example: When the consumer’s income rises by 3% and the demand rises by 7%, it is the case of income elasticity greater than unity.
Diagram
In the given figure, quantity demanded and consumer’s income is measured along X-axis and Y-axis respectively. The small rise in income from OY to OY1 has caused greater rise in the quantity demanded from OQ to OQ1 and vice versa. Thus, the demand curve DD shows income elasticity greater than unity.
(b)Income elasticity equal to unity (EY = 1)
If the percentage change in quantity demanded for a commodity is equal to percentage change in income of the consumer, it is said to be income elasticity equal to unity. For example: When the consumer’s income rises by 5% and the demand rises by 5%, it is the case of income elasticity equal to unity.
Diagram
In the given figure, quantity demanded and consumer’s income is measured along X-axis and Y-axis respectively. The small rise in income from OY to OY1 has caused equal rise in the quantity demanded from OQ to OQ1 and vice versa. Thus, the demand curve DD shows income elasticity equal to unity.
(c) Income elasticity less than unity (EY < 1)
If the percentage change in quantity demanded for a commodity is less than percentage change in income of the consumer, it is said to be income greater than unity. For example: When the consumer’s income rises by 5% and the demand rises by 3%, it is the case of income elasticity less than unity.
Diagram
In the given figure, quantity demanded and consumer’s income is measured along X-axis and Y-axis respectively. The greater rise in income from OY to OY1 has caused small rise in the quantity demanded from OQ to OQ1 and vice versa. Thus, the demand curve DD shows income elasticity less than unity.

2. Negative income elasticity of demand ( EY < 0)

If there is inverse relationship between income of the consumer and demand for the commodity, then income elasticity will be negative. That is, if the quantity demanded for a commodity decreases with the rise in income of the consumer and vice versa, it is said to be negative income elasticity of demand. For example:
As the income of consumer increases, they either stop or consume less of inferior goods.
Diagram
In the given figure, quantity demanded and consumer’s income is measured along X-axis and Y-axis respectively. When the consumer’s income rises from OY to OY1 the quantity demanded of inferior goods falls from OQ to OQ1 and vice versa. Thus, the demand curve DD shows negative income elasticity of demand.

3. Zero income elasticity of demand ( EY=0)

If the quantity demanded for a commodity remains constant with any rise or fall in income of the consumer and, it is said to be zero income elasticity of demand. For example: In case of basic necessary goods such as salt, kerosene, electricity, etc. there is zero income elasticity of demand.
Diagram
In the given figure, quantity demanded and consumer’s income is measured along X-axis and Y-axis respectively. The consumer’s income may fall to OY1 or rise to OY2 from OY, the quantity demanded remains the same at OQ. Thus, the demand curve DD, which is vertical straight line parallel to Y-axis shows zero income elasticity of demand.
3.Cross Elasticity of Demand: The cross elasticity of demand refers to the change in quantity demanded for one commodity as a result of the change in the price of another commodity. This type of elasticity usually arises in the case of the interrelated goods such as substitutes and complementary goods. The cross elasticity of demand for goods X and Y can be expressed as:
                     Ed = Proportionate change in purchase of  X Commodity
                         Proportionate change in the Price of Y commodity
                    
The two commodities are said to be complementary, if the price of one commodity falls, then the demand for other increases, on the contrary, if the price of one commodity rises the demand for another commodity decreases. For example, petrol and car are complementary goods.
While the two commodities are said to be substitutes for each other if the price of one commodity falls, the demand for another commodity also decreases, on the other hand, if the price of one commodity rises the demand for the other commodity also increases. For example, tea and coffee are substitute goods.
TYPES OF CROSS ELASTICITY OF DEMAND
1.     Positive cross elasticity of demand:  When increase in the price of one commodity (Y) leads to an increase in the demand for the other commodity (X), and cross elasticity will be positive because a decrease in the price of one decrease the demand for the other. Example – Substitute goods.
2.     Negative cross elasticity of demand: When increase in the price of one commodity (Y) leads to decrease in the demand for the other commodity (X).
3.     Zero cross elasticity of demand:  When the price of one commodity changes that does not affect the demand of other commodity.

4.Total Expenditure Method:

Dr. Marshall has evolved the total expenditure method to measure the price elasticity of demand. According to this method, elasticity of demand can be measured by considering the change in price and the subsequent change in the total quantity of goods purchased and the total amount of money spent on it.
Total Outlay = Price X Quantity Demanded
In the Table we find three possibilities:

A. More Elastic Demand:

When price is Rs. 10 the quantity demanded is 1 unit and total expenditure is 10. Now price falls from Rs. 10 to Rs. 6, the quantity demanded increases from 1 to 5 units and correspondingly the total expenditure increases from Rs. 10 to Rs. 30. Thus it is clear that with the fall in price, the total expenditure increases and vice-versa. So elasticity of demand is greater than one or ED >1.

B. Unitary Elastic Demand:

If price is Rs. 6, demand is 5 units so the total outlay is Rs. 30. Now price falls to Rs. 5, the demand increases to 6 units but the total expenditure remains the same i.e., Rs. 30. Thus it is clear that with the rise or fall in price, the total expenditure remains the same. The elasticity of demand in this case is equal to one or ED = 1.

C. Less Elastic Demand:

If price is Rs. 5, demand is 6 and total outlay is Rs. 30. Now price falls from Rs. 5 to Re. 1. The demand increases from 6 units to 10 units and hence the total expenditure falls from Rs. 30 to Rs. 10. Thus it is clear that with the fall in price, the total expenditure also falls and vice-versa. In this case, the elasticity of demand is less than one or ED <1.
Diagrammatic Representation:

The total expenditure can be explained with the help of Fig. 7.
In the fig., there are three phases of the total expenditure curve.
Downward sloping (from A to D), (ii) Vertical (from D to G), (iii) Upward sloping (G to J).
5 .Geometric Method/ Point Elasticity Method
If elasticity of demand is to be measured on the point of demand curve following formula is to be used
Ed = Lower segment from the point          
         Upper segment from the point
This method was also suggested by Marshall and it takes into consideration a straight line demand curve and measures elasticity at different points on the curve. This method has now become very popular method of measuring elasticity. In this we take a straight line demand curve, which connects the demand curve with both the axes OX and OY. In the diagram OX axis represents the quantity demanded and OY axis represents the price.
Case (i) Linear Demand Curve:
In Fig. 8 RS is a straight line demand curve. Initially, price is OP or QA and OQ or PA is the initial demand. At OP’ new price the demand is OQ’. At point R elasticity of demand can be measured with the following formula.
Diagram

Case (ii) Non-Liner Demand Curve:

It is possible that the demand curve is not a straight line but a curve. Even then the above technique shall be applicable. The only change to be made is that a tangent is drawn on the demand curve at a point at which we want to measure elasticity of demand. In Fig 10 DD1 is the demand curve and we draw a line RS to measure the elasticity of demand. At point A demand curve DD1 and RS line touches each other. There for, both have same slope. Therefore, a point A, elasticity of demand is Ed = AS/AR
Diagram
NOT IN SYLLABUS

6. Arc Elasticity of Demand:

“Arc elasticity is a measure of the average responsiveness to price change exhibited by a demand curve over some finite stretch of the curve” Prof. Baumol
“Arc elasticity is the elasticity at the mid-point of an arc of a demanded curve” Watson
“When elasticity is computed between two separate points on a demand curve, the concept is called Arc elasticity” Leftwitch
Diagram 
6.Advertising Elasticity of Demand:  The responsiveness of the change in demand to the change in advertising or rather promotional expenses is known as advertising elasticity of demand. In other words, the change in the demand as a result of the change in advertisement and other promotional expenses is called as the advertising elasticity of demand. It can be expressed as: 
Numerically,
Where,
Q1 = Original Demand
Q2= New Demand
A1= Original Advertisement Outlay
A2 = New Advertisement Outlay
These are some of the important types of elasticity of demand that helps in understanding the criteria of demand for the goods and services and the factors that influence the demand.

Revenue Method: (Not in syllabus)

Mrs. Joan Robinson has given this method. She says that elasticity of demand can be measured with the help of average revenue and marginal revenue. Therefore, sale proceeds that a firm obtains by selling its products are called its revenue. However, when total revenue is divided by the number of units sold, we get average revenue.
On the contrary, when addition is made to the total revenue by the sale of one more unit of the commodity is called marginal revenue. Therefore, the formula to measure elasticity of demand can be written as,
EA = A/ A-M
Where Ed represents elasticity of demand, A = average revenue and M = marginal revenue. This method can be explained with the help of a diagram 12.
In this diagram 12, revenue has been shown on OY- axis while quantity of goods on OX-axis. AB is the average revenue or demand curve and AN is the marginal revenue curve. At point P on demand curve, elasticity of demand is calculated with the formula,
Diagram
In this way, value of Ep is one which means that price elasticity of demand is unitary. Similarly, if it is more than one, price elasticity of demand is greater than one and if it is less than one, price elasticity of demand is less than unity.
Factor affecting Price elasticity:-
1.       Nature of Goods: - The elasticity of demand is of necessary goods is less than one Ed<1. The elasticity of demand of luxury good is greater than one Ed>1. The elasticity of demand of comfort goods is equals to one Ed=1
2.       Availability of Substitutes:- If the substitutes of goods are available than elasticity of demand is high or elastic demand Ed>1 and if the substitutes are not available than demand is in elastic Ed<1
3.       Postponement of Consumption:-If the consumption of goods cannot be postponement, than elasticity of demand is less than one Ed<1 like medicines. If the consumption of goods can be postponed the demand of good is elastic Ed>1.
4.       Number of Uses:- If the commodity has several uses, than its demand will be elastic Ed>1 like milk and if the number of uses of commodity is less than demand of commodity is in elastic Ed<1
5.       Time period: - Demand is generally inelastic in the short period and more elastic in long run.
6.       Habit of consumer:- If consumer is habitual for the consumption of commodity, than the demand will be inelastic Ed<1


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