ERUPA SCIENCE & COMMERECE ACADMY

Economics Notes
Q. No. 8: Answer: INTRODUCTION: The law of demand expresses the inverse relationship between price and quantity demanded. It is common observation that when price of a commodity falls consumers buy more of it and with a rise in price consumers buy less of it. The law of demand tells us about the directions of change in Qd and price, but it does not describe how to measure the change. The concept which measures the change of Qd due to change in price called elasticity of demand. DEFINITION: Elasticity of demand can be defined as: The degree of responsiveness in the quantity demanded of a product in response to a change in its price. According to LIPSY: The ration of percentage change in demand to the percentage change in price. EXPLANATION: Elasticity of demand shows the variation of Qd due to change in price. If the change in price brings equal change in Qd then this is called unitary elasticity of demand. If a little change in price brings greater change in Qd, the demand is said to be highly or more elastic. If greater change in Price brings small change in Q d, it is said to be less elastic. Coefficient of Ed: These are as follows: 1: Ed = 1 2: Ed > 1 3: Ed < 1 Define Elasticity of demand. How it is measured?

(Unitary Elastic) (More Elastic) (Less Elastic)

Measurement of Ed: There are three methods to measure elasticity of demand. 1: Total Expenditures Method 2: Percentage Method 3: Geometric Method 1: TOTAL EXPENDITURE METHOD: Total expenditures can be calculated as: T. E = PxQ Ed = 1: If with a change in price total expenditures remains same, the elasticity of demand is equal to 1.

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Economics Notes
Schedule: P 10 5 Qd 50 100 T. E. 500 500

According to this schedule when price falls from 10 to 5, Qd expands from 50 to 100, while T. E. remains same. Therefore elasticity of demand is equal to unity. Diagram:
y-axis

D
P

P R I C E

10 5

a b
Qd

D/
x-axis

50 In the above diagram Qd = P Therefore it shows Ed = 1

Qd

100

Ed > 1: If with a fall in price T. E increases and with aa rise in price T. E. decreases, then Ed > 1. Schedule: P 10 5 Qd 50 150 T. E. 500 750

The above schedule shows that when price falls from 10 to 5, Qd expands from 50 to 150. Total expenditures increases form 500 to 750. Therefore elasticity of demand is greater than 1. Diagram:
y-axis

D
P

P R I C E

10 5

a b
Qd

D/
x-axis

50 In the above diagram Qd > P Therefore it shows Ed > 1 Ed < 1:

100 150
Qd

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Economics Notes
If with a fall in price T. E. decrease and with a rise in price T. E. increases then elasticity of demand will be less than one. Schedule: P 10 5 Qd 50 75 T. E. 500 375

The above schedule shows that when price falls from 10 to 5, Qd expands from 50 to 75. Total expenditures decreases from 500 to 375. Therefore elasticity of demand is les than one. Diagram:
y-axis

D
P

P R 10 I C 5 E

a b Qd D/
x-axis 50 75 100

Qd

In the above diagram Qd < P Therefore it shows Ed < 1 2: PERCENTAGE METHOD: In this method, elasticity of demand can be measured by comparing percentage change in Qd with percentage change in price. Percentage Change in price Ed = Percentage change in P If percentage change in Qd is equal to percentage change in price, elasticity of demand is equal to 1. If percentage change in Qd is greater than percentage change in price, elasticity of demand is greater than 1. If percentage change in Qd is less than percentage change in price, elasticity of demand is less than 1. Mathematically, it can be calculated as: Q P Ed = P Q Schedule: P Qd 10 50 5 100

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Economics Notes
Ed = Q2 Q1 P2 + P 1 Q2 + Q1 P2 P 1 100 50 5 + 10 100 + 50 5 10 50 15 1 = 150 5 1

Ed =

Ed =

Ed = 1 | Ed |= 1 ( Ignoring Negative Sign)

Here Ed is equal to one (unit or elastic demand) 3: GEOMETRIC METHOD: Elasticity of demand can be measured at a single point on demand curve bus using geometrical method. Formula: Ed = Lower Portion of Demand Curve Upper Portion of Demand Curve y-axis D/ T Ed >1 P R I C E R Ed =1 S Ed <1 Qd D x-axis

Elasticity of demand at point R: Lower portion of demand curve = RD Upper portion of demand curve = RD/ RD Ed = (Ed = 1) RD / Elasticity of demand at point T: Lower portion of demand curve = TD Upper portion of demand curve = TD/ TD Ed = (Ed > 1) TD / Elasticity of demand at point T: Erupa Academy Composed & Designed By: Basit butt

ERUPA SCIENCE & COMMERECE ACADMY

Economics Notes
Lower portion of demand curve = SD Upper portion of demand curve = SD/ SD Ed = (Ed < 1) SD / If Demand curve is not a straight line:

A D

A/ T

T/ D

B/

Elasticity of demand at point T: Lower portion of demand curve = Upper portion of demand curve = Lower Portion of Demand Curve TB Ed = = Upper Portion of Demand Curve TA Elasticity of demand at point T: Lower portion of demand curve = Upper portion of demand curve = / / Lower Portion of Demand Curve T B Ed = = Upper Portion of Demand Curve T / A/

TB TA

T/B/ T/A/

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