Price elasticity and Income elasticity of demand
Price elasticity of demand - It is the responsiveness of the quantity demanded of a commodity to the change in its price.
Mathematically, it is equal to the ratio of percentage change in quantity demanded to the percentage change in price.
Cast 1 - when e > 1
- e > 1 ⇒ % Δ quantity demanded > % Δ Price
- It means the price remains somewhat stable inspite the quantity demanded is increased.
- i.e., demand is elastic (Elastic demand).
- Its demand curve is somewhat flatter.
Case 2 - when e < 1
- e < 1, i.e., % Δ Quantity demanded < % Δ Price
- It means price decreases sharply with little increase in quantity.
- i.e., demand is inelastic (Inelastic demand).
- Its demand curve is somewhat slanting.
Case 3 - when e = 1
- e = 1, i.e., % Δ quantity demanded = % Δ price.
- It means the price decreases in the same proportion as the quantity demanded increases, and vice-versa.
- i.e., the demand is Unitary elastic.
- Its curve is at an angle of 45𝆩.
Determinants of price elasticity of demand (e)
- Nature of commodity
- Necessity - inelastic demand
- Luxury items - elastic demand
- Availability of substitute
- Available - elastic demand
- Not available - inelastic demand
More choice ⇒ More elastic demand
Case 4 - e → ∞
- e → ∞, i.e., % Δ Price → 0
- The demand is perfectly elastic (Perfectly elastic demand).
- Its demand curve is parallel to the x-axis (i.e., quantity demanded).
- The price remains stable.
Case 5 - When e = 0
- e = 0, i.e., the demand is perfectly inelastic (Perfectly inelastic demand).
- Its demand curve is parallel to the y-axis (i.e., Price).
- Example - Basic necessities which are abundant, such as Salt.
Note - Agriculture commodities are inelastic.
- Prices of agricultural commodities are volatile.
- Therefore, its demand and supply are inelastic, which will increase the vulnerability of the farmers.
Paradox of poverty of the farmers
Let the cost of production be ₹40,000.
Revenue in 1st case = 10 x ₹10,000 = ₹1,00,000
Therefore, profit = ₹60,000
Now in second case, let the production be increased, so the supply curve shifts rightward.
Revenue in 2nd case = 2 x ₹15,000 = ₹30,000
Therefore, the farmer suffers loss of ₹10,000 inspite of increase in production.
Cross elasticity of demand - It is the responsiveness in quantity demanded of one good when the price of another good undergoes a change.
- For substitute good it is positive and
- For complementary good it is negative.
Difference between elastic and inelastic commodity
- Elastic commodity
- The increase in supply of elastic commodity leads to slightly decrease in price (not sharply).
- Inelastic commodity
- The slightly increase in supply of inelastic commodity results into significantly decrease in price.
Income elasticity of demand - It is the responsiveness of the quantity demanded of a commodity to the change in income.
Case 1 - when e >1
- i.e., % Δ Q > % Δ Y
- i.e., The demand is income elastic (Income elastic demand).
- Example - Luxury items
Case 2 - when e < 1
- i.e., % Δ Q < % Δ Y
- i.e., the demand is income inelastic (Income inelastic demand).
- Example - Necessary items
Case 3 - when e = 1
- i.e., % Δ Q = % Δ Y
- i.e., the demand is unitary income elastic.
Case 4 - when e → ∞
- i.e., the demand is perfectly income elastic.
Case 5 - when e = 0
- i.e., the demand is perfectly income inelastic.
- Example - Necessity (which are in abundant) such as Salt.
Case 6 - when e < 0
- i.e., e is negative.
- It means increase in income results into decrease in quantity demanded.
- For example - inferior goods
Note
- For normal goods, Y ↑ ⇒ Q ↑ (i.e., positive realtion)
- For inferior goods, Y ↑ ⇒ Q ↓ (i.e., negative relation)
Inferior goods - These are the goods whose demand decreases with the increase in income and vice-versa.
It shows unusual relation between income and demand.
Giffen goods - It was named after Sir Robert Giffen.
These are the inferior goods whose demand increases with the increase in price and vice-versa.
It shows unusual relation between price and demand.
It rarely happens, mainly when substitutes are not available.
A giffen good has an upward sloping demand curve which is contrary to the fundamental law of demand (which is based on downward sloping demand curve).
Veblen goods - It was named after T. Veblen. These goods are associated with the social prestige like expensive rare articles, diamonds, designer goods, etc.
Their demand increases with the increase in price.
A Veblen good also has an upward sloping demand curve which also violated the fundamental law of demand.
Previous Article - Market Exchange Rate & Purchasing Power Parity
Next Article - Types of Competition & Resource allocation
Notes on other subjects
Optional Subject
Note - This is my Vision IAS Notes (Vision IAS Class Notes) and Ashutosh Pandey Sir's Public Administration Class notes. I've also added some of the information on my own.
Hope! It will help you to achieve your dream of getting selected in Civil Services Examination 👍
0 Comments