Principles of Business Decision - LAW OF DEMAND, Price Elasticity of Demand, Income Elasticity of Demand

Principles of Business Decision

LAW OF DEMAND

Price Elasticity of Demand

Income Elasticity of Demand

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Law of Demand

Law of demand states that here is a negative (or inverse )relationship between the price of the commodity and quantity demanded, holding other factors constant (cetris paribus). 

 

Some of the factors are:

 income of consumer, price of related goods, taste and preference of buyer etc. 

 

Exemptions: 

_ Inferior or giffen goods

_ Prestige good

_ Consumer’s misconception

_ Change in fashion

Price Elasticity of Demand

 

Price is an important determinant of demand of a product

 

_ Price Elasticity of Demand refers to the extent of change in demand as a result of change in price of the product

 

_ Dr. Marshall has pro-founded the concept of price elasticity of demand.

 

_ the price elasticity of demand ranges from zero to infinity.

_ It can be equal to zero, less than one, greater than one and equal to unity.
 

 

Degrees of price elasticity of demand
 

Perfectly Elastic Demand (Infinite elasticity)
 

Perfectly elastic demand is said to happen when a little change in price leads to an infinite change in quantity demanded.

 

 Elasticity of demand = infinite

In such a case the shape of the demand curve will be horizontal straight line parallel to x axis

 

Perfectly Inelastic Demand

Demand is unaffected by change in price

The elasticity of demand in this case will be equal to zero (ed = 0).

Demand curve will be vertical straight line parallel to y axis

 

 

Unitary Elastic Demand

Given proportionate change in the price level brings about an equal proportionate change in quantity demanded.

Elastic demand is exactly one

Marshall calls it unit elastic.
 

Shape of Unitary Elastic Demand curve will be a rectangular hyperbola

 

 

Relatively Elastic Demand

Small change in price leads to a big change in quantity demanded.

Elasticity of demand is said to be more than one (ed > 1)

DD curve has a flattened slope

 

 

 

Relatively Inelastic Demand

A given percentage changes in price produces a relatively less percentage change in quantity demanded.

Elasticity of demand is said to be less than one (ed < 1)

DD cure has steep downward slope

 

 

 

Measurement of price elasticity of demand 

 

Change in quantity/original quantity X change in price / original price
 

 

Income Elasticity of Demand

Income elasticity of demand measures the responsiveness of demand for a particular good to changes in consumer income
 

Income Elasticity of Demand = % Change in Quantity Demanded / % Change in income
 

Measurement of income elasticity of demand
 

Change in quantity/original quantity X change in income / original income
 

 

Types of Income Elasticity
 

Positive Income Elasticity of Demand
 

When the demand for a product increases with increase in consumer’s income and decreases with decrease in consumer’s income
 

The income elasticity of demand is positive for normal goods and superior goods
 

Dd cure will slop upward from left to right 

 

 

 

Negative Income Elasticity of Demand
 

Demand for a product decreases with increase in consumer’s income.
 

The income elasticity of demand is negative for inferior goods
 

DD Curve slope downward from left to right

 

 

Zero Income Elasticity of Demand

No effect of increase in consumer’s income on the demand of product.

 

The income elasticity of demand is zero (ey = 0) in case of essential goods
 

DD curve is vertical straight line perpendicular to x axis

 

 

Advertisement elasticity of demand

Measures the responsiveness of a good's demand to changes in spending on advertising
 

 

Cross elasticity of demand

Measures the responsiveness in the quantity demanded of one good when the price for another good changes
 

The cross elasticity of demand for substitute goods is always positive
 

The cross elasticity of demand for complementary goods is negative.

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