E-LESSON-3 MICRO ECONOMICS

IDOL Institute of Distance and Online Learning ENHANCE YOUR QUALIFICATION, ADVANCE YOUR CAREER.

BBA/BCOM 2 All right are reserved with CU-IDOL Microeconomics Course Code: BBA103/BCM103 Semester: First e-Lesson: 3 SLM Unit: 3 www.cuidol.in Unit-3(BBA103/BCM103)

MICRO ECONOMICS 33 OBJECTIVES INTRODUCTION Student will be able to define elasticity of demand. In this unit we are going to learn about elasticity of Demand. Identify the factors affecting demand elasticity Describe price elasticity of demand. Under this you will be able to understand the various degrees of elasticity. Discuss the concept of cross elasticity of Students will be able to comprehend demand the importance of elasticity of demand. www.cuidol.in Unit-3(BBA103/BCM103) INSTITUTE OF DISTANACEll ArNigDhtOaNrLeINreEsLeErAvRedNIwNiGth CU-IDOL

TOPICS TO BE COVERED 4 Elasticity of Demand. Degrees of Elasticity Methods of Measuring Elasticity. Importance of Elasticity www.cuidol.in Unit-3(BBA103/BCM103) All right are reserved with CU-IDOL

ELASTICITY OF DEMAND 5  “Elasticity” is a standard measure of the degree of responsiveness (or sensitivity) of one variable to changes in another variable.  Elasticity of Demand measures the degree of responsiveness of demand for a commodity to a given change in any of the independent variables that influence demand for that commodity, such as price of the commodity, price of the other commodities, income, taste, preferences of the consumer and other factors.  Responsiveness implies the proportion by which the quantity demanded of a commodity changes, in response to a given change in any of its determinants . www.cuidol.in Unit-3(BBA103/BCM103) All right are reserved with CU-IDOL

ELASTICITY OF DEMAND 6  Mathematically, it is the percentage change in quantity demanded of a commodity to a percentage change in any of the (independent) variables that determine demand for the commodity.  Four major types of elasticity: 1. Price elasticity, 2. Income elasticity, 3. Cross elasticity 4. Advertising (or promotional) elasticity.  In order to assess the impact of one variable on demand, we assume other variables as constant (ceteris paribus) www.cuidol.in Unit-3(BBA103/BCM103) All right are reserved with CU-IDOL

PRICE ELASTICITY OF 7 DEMAND Price is most important among all the independent variables that affect the demand for any commodity.  Hence Price elasticity of demand ( “ep” or “e”) is considered to be the most important of all types of elasticity of demand.  Price elasticity of demand means the sensitivity of quantity demanded of a commodity to a given change in its own price. www.cuidol.in Unit-3(BBA103/BCM103) All right are reserved with CU-IDOL

DEGREES OF PRICE 8 ELASTICITY  Perfectly elastic demand Price D Quantity  ep=∞ (in absolute terms). P  Unlimited quantities of the commodity can be sold at the prevailing price  A negligible increase in price would result in zero quantity O Q1 Q1 demanded  Horizontal demand curve  Perfectly inelastic demand Price D  The other extreme of the elasticity range P1 Q1 P2  ep=0 (in absolute terms)  Quantity demanded of a commodity remains the same, O irrespective of any change in the price Quantity  Such goods are termed neutral  Vertical demand curve www.cuidol.in Unit-3(BBA103/BCM103) All right are reserved with CU-IDOL

DEGREES OF PRICE ELASTICITY  Highly elastic demand 9 • Proportionate change in quantity demanded is more than Price D a given change in price P1 D • ep >1 (in absolute terms) P2 • Such goods are called luxuries Q2 Quantity O Q1  Unitary elastic demand D Price D Quantity • Proportionate change in price brings about an equal proportionate change in quantity demanded P1 Quantity P2 • ep =1 (in absolute terms). • Demand curves are shaped like a rectangular hyperbola, O Q1 Q2 Price D asymptotic to the axes P1  Relatively inelastic demand P2 • Proportionate change in quantity demanded is less than O D a proportionate change in price Q1 Q2 • ep <1 (in absolute terms) • Such goods are called necessities www.cuidol.in Unit-3(BBA103/BCM103) All right are reserved with CU-IDOL

METHODS OF MEASURING ELASTICITY 10  Ratio (or Percentage) Method →The most popular method used to measure elasticity →Elasticity of demand is expressed as the ratio of proportionate change in quantity demanded and proportionate change in the price of the commodity →It allows comparison of changes in two qualitatively different variables →It helps in deciding how big a change in price or quantity is Proportionate change in quantity demanded of commodityX ep = Proportionate change in price of commodityX ep= Q2  Q1 / Q1 P2  P1 / P1 • where Q1= original quantity demanded, Q2= new quantity demanded, P1= original price level, P2= new price level www.cuidol.in Unit-3(BBA103/BCM103) All right are reserved with CU-IDOL

POINT ELASTICITY METHOD 11  Elasticity measured at a point of demand curve is referred as point elasticity of demand.  For nonlinear demand curve we need to apply calculus to calculate point elasticity.  Point elasticity can be expressed as: ep = dQ / Q = dQ . P dP/ P dP Q www.cuidol.in Unit-3(BBA103/BCM103) All right are reserved with CU-IDOL

ARC ELASTICITY METHOD 12  Used when the available figures on price and quantity are discrete, and it is possible to isolate and calculate the incremental changes.  It is used to find the elasticity at the midpoint of an arc between any two points on a demand curve, by taking the average of the prices and quantities.  This method finds wider applications, as it reflects a movement along a portion (arc) of a demand curve ep = Q2  Q1 / P2  P1 (Q1  Q2 ) / 2 (P1  P2 ) / 2 = Q2  Q1 . P1  P2 Q1  Q2 P2  P1 www.cuidol.in Unit-3(BBA103/BCM103) All right are reserved with CU-IDOL

TOTAL OUTLAY METHOD (MARSHALL) 13  Elasticity is measured by comparing expenditure levels before and after any change in price, i.e. whether the new expenditure is more than, or less than, or equal to the initial expenditure level.  Helps a seller in taking a decision to raise price only if:  Reduction in quantity demanded does not reduce total revenue or  Reduction in price increases the quantity demanded to the extent that total revenue also increases.  Degrees  When demand is elastic, a decrease in price will result in an increase in the revenue (sales).  When demand is inelastic, a decrease in price will result in a decrease in the revenue (sales).  When demand is unit-elastic, an increase (or a decrease) in price will not change the revenue (sales) www.cuidol.in Unit-3(BBA103/BCM103) All right are reserved with CU-IDOL

DETERMINANTS OF PRICE 14 ELASTICITY OF DEMAND  Nature of commodity -Necessities are relatively price inelastic, while luxuries are relatively price elastic  Availability and proximity of substitutes -Price elasticity of demand of a brand of a product would be quite high, given availability of other substitute brands  Alternative uses of the commodity-If a commodity can be put to more than one use, it would be relatively price elastic.  Proportion of income spent on the commodity- The greater the proportion of income spent on a commodity, the more sensitive would the commodity be to price  Time- Demand for any commodity is more price elastic in the long run  Durability of the commodity- Perishable commodities like eatables are relatively price inelastic in comparison to durable items  Items of addiction- Items of intoxication and addiction are relatively price inelastic. www.cuidol.in Unit-3(BBA103/BCM103) All right are reserved with CU-IDOL

REVENUE AND PRICE 15 ELASTICITY OF DEMAND  For relatively inelastic demand, a change in price would have a greater effect on revenue than a change in quantity demanded  AR is same as the price of the product  Demand curve is also the AR curve of the firm.  Marginal Revenue is the revenue a firm gains in producing one additional unit of a commodity www.cuidol.in Unit-3(BBA103/BCM103) All right are reserved with CU-IDOL

REVENUE AND PRICE 16 ELASTICITY OF DEMAND  Till ep>1 MR is positive and TR is rising Price,  At the midpoint of the demand curve, ep=1 and MR Revenue ep=∞ is equal to 0 and TR is at its peak ep>1  When ep<1, MR is negative ep=1  MR= AR[1- ep] ep<1 O MR ep=0 Quantity Price, Revenue www.cuidol.in Unit-3(BBA103/BCM103) O TR Quantity All right are reserved with CU-IDOL

INCOME ELASTICITY OF DEMAND 17 (EY)  ey measures the degree of responsiveness of demand for a good to a given change in income, ceteris paribus. Proportionate change in quantity demanded of commodityX ey = Proportionate change in income of consumer  Degrees:  Positive income elasticity • Demand rises as income rises and vice versa • Normal good  Negative income elasticity • Demand falls as income rises and vice versa • Inferior good www.cuidol.in Unit-3(BBA103/BCM103) All right are reserved with CU-IDOL

CROSS ELASTICITY OF DEMAND 18  ec measures the responsiveness of demand of one good to changes in the price of a related good Proportionate change in quantity demanded of commodityX ec = Proportionate change in price of commodityY  Degrees  Negative Cross Elasticity  Complementary goods  Positive Cross Elasticity  Substitute goods www.cuidol.in Unit-3(BBA103/BCM103) All right are reserved with CU-IDOL

PROMOTIONAL ELASTICITY OF DEMAND 19  iAndcvuerrritnisginagn(o“er xppreonmdoittuiornea” l)onelaasdtviceirtytisoinf gd,evmisa-nàd-v(iseaa) nmienacsreuaresse the effect of in demand, ceteris paribus.  Some goods (like consumer goods) are more responsive to advertising than others (like heavy capital equipments). ea = Proportionate change in quantity demanded (or sales)of commodityX Proportionate change in advertising expenditure  Degrees  ea>1  Firm should go for heavy expenditure on advertisement.  ea <1  Firm should not spend too much on advertisement www.cuidol.in Unit-3(BBA103/BCM103) All right are reserved with CU-IDOL

IMPORTANCE OF ELASTICITY 20  Determination of price  Elasticity is the basis of determining the price of a product keeping its possible effects on the demand of the product in perspective  Basis of price discrimination  Products having elastic demand may be sold at lower price, while those having inelastic demand may be sold at high prices  Determination of rewards of factors of production  Factors having inelastic demand are rewarded more than factors that have relatively elastic demand.  Government policies of taxation  Goods having relatively elastic demand are taxed less than those having relatively inelastic demand. www.cuidol.in Unit-3(BBA103/BCM103) All right are reserved with CU-IDOL

Multiple Choice Questions 1. If demand is price elastic, 21 A) a 1 percent decrease in the price leads to an increase in the quantity demanded that exceeds 1 percent. B) a 1 percent increase in the price leads to an increase in the quantity demanded that exceeds 1 percent. C) the price is very sensitive to any shift of the supply curve. D) a 1 percent decrease in the price leads to a decrease in the quantity demanded that is less than 1 percent. 2. The price elasticity of demand can range between A) negative one and one. B) zero and infinity. C) zero and one. D) negative infinity and infinity Answers: 1.A) 2. B) www.cuidol.in Unit-3(BBA103/BCM103) All right are reserved with CU-IDOL

Multiple Choice Questions 22 3. If the price elasticity is between 0 and 1, demand is A) inelastic. B) elastic. C) perfectly elastic. D) unit elastic. 4. When the price elasticity of demand for a good equals A) 0, the demand curve is horizontal. B) 1, the demand curve is vertical. C) 1, the demand curve is horizontal. D) 0, the demand curve is vertical. Answers: 3. A) 4.D) www.cuidol.in Unit-3(BBA103/BCM103) All right are reserved with CU-IDOL

Summary 23  Arc elasticity: It computed if the data is discrete and therefore incremental change is measurable.  Cross elasticity: Degree to which demand for one product is affected by the price of another product. Demand elasticity: Elasticity used to show the responsiveness of the quantity demanded of a good or service to a change in its price.  Elasticity: It measures the degree of responsiveness of demand/supply to change in price.  Point elasticity: It computed if demand function is continuous and therefore only marginal changes are calculable.  Promotional Elasticity of Demand- Advertising (or promotional) elasticity of demand (ea) measures the effect of incurring an “expenditure” on advertising, vis-à-vis an increase in demand, ceteris paribus. www.cuidol.in Unit-3(BBA103/BCM103) All right are reserved with CU-IDOL

FAQ’S 24 Q.1 Define Elasticity? Ans: Elasticity of demand tells the degree of responsiveness of consumer to a price change. It is measured as: ep = Percentage change in quantity demanded ------------------------------------------------------ Percentage change in price Q.2 What is Arc Elasticity ? Ans: The arc elasticity is a measure of average elasticity, that is, the elasticity at the midpoint of the chord that connects the two points (A and B) on the demand curve defi ned by the initial and new price levels. Q.3 What is meant by cross elasticity of Demand ? Ans :The cross elasticity of demand is a numerical measure of the degree to which quantity demanded of a good responds to changes in the prices of other commodities, the other determinants of demand being kept constant. www.cuidol.in Unit-3(BBA103/BCM103) All right are reserved with CU-IDOL

REFERENCES 25 1. Dwivedi D.N. , Managerial Economic, Vikas Publications, New Delhi. 2. Mithani D.M. , Managerial Economics Theory and Applications, Himalaya Publication, Mumbai. 3. https://www.economicsonline.co.uk/Competitive_markets/Price_elasticity_of_demand.html 4. https://www.toppr.com/guides/business-economics/theory-of-demand/elasticity-of-demand/ www.cuidol.in Unit-3(BBA103/BCM103) All right are reserved with CU-IDOL

26 THANK YOU For queries Email: [email protected] www.cuidol.in Unit-3(BBA103/BCM103) All right are reserved with CU-IDOL