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Measuring Elasticity of Demand

Measuring Elasticity of Demand

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Measuring Elasticity of Demand

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  1. Elasticity of Demand & Demand Estimation

  2. Elasticity of Demand • Law of demand just talks about “Directional” impact of the change • Manager need to know about magnitude of impact

  3. Elasticity of demand % Change in quantity demanded of good Ed = ------------------------------------------------------------------------ % Change in determinant Z Δq/q Δq * z Ed = ------------------- = --------------- Δz/z Δz * z

  4. Kinds of elasticity Measurement • Arc & point

  5. Point elasticity • elasticity at a particular point of demand curve ΔQ *Z • E = ------ ΔZ *Q • If ΔZ is small ΔQ /ΔZ = slope of original Z & Q dQ *Z • E = ------ dZ *Q

  6. Arc elasticity • Measuring elasticity over larger segment of the demand curve • It is the measure of average elasticity • Average elasticity: The elasticity of the mid point of the chord that connects the initial & new point of demand curve

  7. Average elasticity Price of x Mid Point P1 P2 Quantity of X O Q1 Q2

  8. Lets derive arc elasticity • Coordinates of midpoint {(P1+P2/2),(Q1+Q2)} • ΔP-Change in price • ΔQ-Change in quantity ΔQ ΔP e= ----- % ------ (Q1+Q2)/2 (P1+P2)/2 2ΔQ 2ΔP e= ----- % ------ (Q1+Q2) (P1+P2)

  9. Lets derive arc elasticity ΔQ P1+P2 E= ----- * ------ (Q1+Q2) ΔP ΔQ*P1+P2 = --------------- ΔP *Q1+Q2

  10. Price elasticity of demand • The measure of relative response of quantity demanded to price along a given demand curve Proportionate change in demand of good x • E=------------------------------------------ Proportionate change in price of good x (Q2-Q1)/Q1 =---------------- (P2-P1)/P1

  11. Rewritten as -ΔQ/Q1 • E= ------- ΔP/P1 -ΔQ.P1 = ----------- ΔP/P1

  12. Types of price elasticity • Nature of demand influences elasticity • Perfectly elastic demand • Absolute inelastic demand • Unit elasticity of demand • Relative elastic demand • Relative inelastic demand

  13. Perfectly elastic Demande=∞,Theoretical D D P0 Price of good X ΔX X1 X2 Units demanded of good X

  14. Absolute inelastic demande=0,Theoretical Change in price cause no changes D P0 Δp Price of good X P1 D X Units demanded of good X

  15. Unit elasticity of Demande=1 D D Price of good X P0 ΔP P1 ΔX D X1 X2 Units demanded of good X

  16. Relative elastic Demande>1 D D P0 Price of good X ΔP P1 ΔX D X0 X1 Units demanded of good X

  17. Relative Inelastic Demande<1 D P0 ΔP Price of good X P1 ΔX D X0 X1 Units demanded of good X

  18. Measurement of price elasticity of demand • Analytical Approach • Slope Measure • Graphical measure • Total outlay method

  19. Analytical approach or percentage measure % change in quantity demanded E = ---------------------------- % change in price demanded Δqp Point e = ----- Δpq Δq(p1+p2) Arc( Point )e = ----------- Δp(q1+q2)

  20. Graphical Measure – Visual Inspection AB – Linear Demand Curve e at pt C w.r.to pt P =BC/AC Lower segment of demand curve e=------------------------------------------- Upper portion of demand curve A e>1 e =1 P1 e<1 B

  21. Slope measure method/Mathematical method • Point elasticity of demand • Using differential calculus • Slope of demand curve at any point is expressed by differential dp/dq • Reciprocal of slope =dq/dp • E =reciprocal of slope*(original price/original quantity)

  22. Direction of change in price & total revenue Same Opposite Change in price does not change TR Elasticity E <1 (Relatively elastic) E >1 (Relatively inelastic) E =1 Outlay Method

  23. elastic Inelastic Lower price Increase price Price policy decision to improve revenue

  24. Relationship b/w price elasticity of demand, Average revenue & Marginal revenue • Total sales revenue is the total sales proceeds • TR=P*Q • MR=d(TR)/dQ • MR=d(PQ)/dQ =PdQ/dQ+QdP/dQ • According to differentiation • =P+dP/dQ.Q

  25. =p(1+{dp/dq}*q/p) • =p(1+1/E)

  26. The determinants of price elasticity of demand • The number & closeness of substitutes • Large number of close substitutes means more elastic demand • The share of the commodity in buyers budget • Nature of the commodity (Necessities, Luxuries) • Number of use the commodity can be put to • Habit forming characteristics • Time period • Short Run • Long Run Salt Cigarettes Alcohol

  27. Income elasticity of demand % change in quantity demanded Ey = ------------------------------------------- % change in quantity demanded Δqx/qx = -------- Δy/y qx – Quantity demanded of good X Y - Income level of consumers

  28. Type of income elasticity • High Income Elasticity • Unitary Income elasticity • Low Income Elasticity • Zero Income Elasticity • Negative Income elasticity

  29. High income elasticity Ey>1 Income of the household D Δy D Δx O Units of the good X demanded by household

  30. Unitary income elasticity Ey=1 Income of the household D Δy Δx D O Units of the good X demanded by household

  31. Low income elasticity Ey<1 Income of the household D Δy Δx D O Units of the good X demanded by household

  32. Zero income elasticity Ey>1 Income of the household D Δy D O Units of the good X demanded by household

  33. Negative income elasticity Ey<0 Income of the household D Inferior Goods Δy Δx D O Units of the good X demanded by household

  34. Income b/w income elasticity of goods • The sum of income elasticity for all goods consumed by a consumer must add up to unity. • kxexi+kyeyi =1 • Kx – Propotion of income spend on good X • exi - Income elasticity of demand for goodX • Ky - Propotion of income spend on good y • eyi- Income elasticity of demand for good y No Savings & Borrowings

  35. Differences b/w income elasticity of demand & income sensitivity of demand • Income elasticity of demand • Change in physical units purchased as a result of income changes • Income sensitivity of demand • Change in rupee expenditure due to change in income

  36. Income sensitivity of demand % change in rupee Coefficient of expenditure during period t income sensitivity = ---------------------------- during period “t” % change in disposable income during period t Note:- The coefficient values are only approximate

  37. Relation b/w income elasticity of demand & propensity to consume

  38. Marginal Propensity to Consume Ratio of change in consumption expenditure to change in income MPC=Δc/Δy

  39. Average propensity to consume • Ratio of aggregate consumption to aggregate income • APC=C/Y

  40. Income Elasticity of Demand

  41. Income elasticity of demand % Change in quantity demanded = -------------------------------------------- % Change in income ΔC/C = -------- ΔY/Y ΔC*Y = -------- ΔY*C MPC = ------- APC

  42. Use of Income Elasticity of Demand • Planning for firms growth • Forecasting Demand • Formulating Marketing Strategies

  43. Choice of income measure • Personal disposable income per head • Personal disposable Income per family • Transitory Income • Discretionary Income

  44. Cross Elasticity of Demand Occurs because of substitutes or complement product

  45. Cross Elasticity of Demand [Δqx] [Δpy] Exy = -------- / -------- [qx] [py] Δqx*py = ---------- Δpy*qx

  46. Note • Cross Elasticity will have positive sign if two goods are substitutes • Cross Elasticity will have negative sign if two goods are complements • If two goods are unrelated the cross elasticity will be zero

  47. Promotional Elasticity of demand

  48. Relation b/w sales and advertisements • At minimum level of sales, no advertising is needed • Beyond minimum level of sales, there is a direct relationship b/w advertising expenditure & sales • Consumer generally need a minimum level of advertisement before they take notice of the presence of a product

  49. Advertising Elasticity of Demand • It measures the response of quantity demanded to the change in expenditure on advertisement & other sales promotion activity • Point formula • EA=(ΔQ/ΔA)*(A/Q) • Q - Quantity of good X sold • A -Units of advertising expenditure on good X

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