Assignment Set-I

Q1. Price elasticity of demand depends on various factors. Explain each factor with the help of an example. Answer.

Elasticity of Demand:

Earlier we have discussed the law of demand and its determinants. It tells us only the direction of change in price and quantity demanded. But it does not specify how much more is purchased when price falls or how much less is bought when price rises. In order to understand the quantitative changes or rate of changes in price and demand, we have to study the concept of elasticity of demand. Meaning and Definition

The term elasticity is borrowed from physics. It shows the reaction of one variable with respect to a change in other variables on which it is dependent. Elasticity is an index of reaction. In economics the term elasticity refers to a ratio of the relative changes in two quantities. It measures the responsiveness of one variable to the changes in another variable. Elasticity of demand is generally defined as the responsiveness or sensitiveness of demand to a given change in the price of a commodity. It refers to the capacity of demand either to stretch or shrink to a given change in price. Elasticity of demand indicates a ratio of relative changes in two quantities.ie, price and demand. According to prof. Boulding. “Elasticity of demand measures the responsiveness of demand to changes in price” 1 In the words of Marshall,” The elasticity (or responsiveness) of demand in a market is great or small according to the amount demanded much or little for a given fall in price, and diminishes much or little for a given rise in price” 2. Kinds of elasticity of demand

Broadly speaking there are five kinds of elasticity of demand. They are Price Elasticity, Income Elasticity, Cross Elasticity, Promotional Elasticity and Substitution Elasticity. We shall discuss each one of them in some detail. 1. Price Elasticity of Demand

In the words of Prof. Stonier and Hague, price elasticity of demand is a technical term used by economists to explain the degree of responsiveness of the demand for a product to a change in its price. where Ep is price elasticity

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It implies that at the present level with every change in price, there will be a change in demand four times inversely. Generally the co-efficient of price elasticity of demand always holds a negative sign because there is an inverse relation between the price and quantity demanded. Symbolically Ep =

Original demand = 20 units original price = 6 – 00

New demand = 60 units New price = 4 – 00

In the above example, price elasticity is – 6.

The rate of change in demand may not always be proportionate to the change in price. A small change in price may lead to very great change in demand or a big change in price may not lead to a great change in demand. Based on numerical values of the co-efficient of elasticity, we can have the following five degrees of price elasticity of demand. Different Degree of Price Elasticity of Demand

1. Perfectly Elastic Demand: In this case, a very small change in price leads to an infinite change in demand. The demand curve is a horizontal line and parallel to OX axis. The numerical co-efficient of perfectly elastic demand is infinity (ED=)

2. Perfectly Inelastic Demand: In this case, what ever may be the change in price, quantity demanded will remain perfectly constant. The demand curve is a vertical straight line and parallel to OY axis. Quantity demanded would be 10 units, irrespective of price changes from Rs. 10.00 to Rs. 2.00. Hence, the numerical co-efficient of perfectly inelastic demand is zero. ED = 0

3. Relative Elastic Demand: In this case, a slight change in price leads to more than proportionate change in demand. One can notice here that a change in demand is more than that of change in price. Hence, the elasticity is greater than one. For e.g., price falls by 3 % and demand rises by 9 %. Hence, the...