Business men know that they face demand curves, but rarely do they know what these curves look like. Yet sometimes a business needs to have a good idea of what part of a demand curve looks like if it is to make good decisions. If Rick's Pizza raises its prices by ten percent, what will happen to its revenues? The answer depends on how consumers will respond. Will they cut back purchases a little or a lot? This question of how responsive consumers are to price changes involves the economic concept of elasticity. Show As developed by Alfred Marshall, the concept of elasticity was applied to elasticity of price. But later on, the concept was made more broader. Elasticity of demand is a concept of showing the responsiveness of demand. As we well-known earlier, changes in demand can be caused by several factors which determine demand for a good or commodity. Obviously, demand is responsive to each of these factors i.e. But all the factors are not equally important from the point of view of either theoretical analysis or practical means. For example, take tastes or preference of the consumers, is an exogenous factor and there is no point in measuring the responsiveness of demand to this factor, though in practice this factor is important. Efforts, therefore are made to measure the responsiveness of demand to changes in certain important factors like price, income, prices of related products, sales promotion etc. Let us take price as a factor for understanding the elasticity concept. When considering the responsiveness of the quantity demanded to change in price of a commodity, we may make some statements such as : 'The demand for sugar was more responsive to price-changes twenty years ago than it is today', or the demand for milk responds more to price changes than does the demand for tea'. It is thus clear that the degree of responsiveness of quantity demanded to price changes varies from product to product. Elasticity of demand indicates the degree of responsiveness of quantity demanded to changes in market price. Hence this becomes the concept of price-elasticity of demand. DEGREES OF PRICE ELASTICITY Different commodities have different price elasticities. Some commodities have more elastic demand while others have relative elastic demand. Basically, 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. According to Dr. Marshall : "The elasticity or responsiveness of demand in a market is great or small according as the amount demanded increases much or little for a given fall in price and diminishes much or little for a given rise in price."However, some particular values of elasticity of demand have been explained as under ; Types of Price Elasticity of Demand:-MEASUREMENT OF PRICE ELASTICITY OF DEMAND There are five methods to measure the price elasticity of demand.
Total Expenditure Method Dr. Marshall has evolved the total expenditure method to measure the price elasticity of demand. According to this method, elasticity of demand can be measured by considering the change in price and the subsequent change in the total quantity of goods purchased and the total amount of money spend on it. Proportionate Method This method is also associated with the name of Dr. Marshall. According to this method, "price elasticity of demand is the ratio of percentage change in the amount demanded to the percentage change in price of the commodity." It is also known as the Percentage Method, Flux Method, Ratio Method, and Arithmetic Method.
In economics, the income elasticity of demand is the responsivenesses of the quantity demanded for a good to a change in consumer income. It is measured as the ratio of the percentage change in quantity demanded to the percentage change in income. If a 10% increase in Mr. Ruskin Smith's income causes him to buy 20% more bacon, Smith's income elasticity of demand for bacon is 20%/10% = 2. Mathematical definitionϵ d = % change in quantity demanded % change in income {\displaystyle \epsilon _{d}={\frac {\%\ {\mbox{change in quantity demanded}}}{\%\ {\mbox{change in income}}}}} The point elasticity version, which defines it as an instantaneous rate of change of quantity demanded as income changes, is as follows. For a given Marshallian demand function
Q
(
I
,
P
→
)
,
{\displaystyle Q(I,{\vec {P}}),}
This can be rewritten in the form ϵ d = ∂ ln Q ∂ ln I {\displaystyle \epsilon _{d}={\frac {\partial \ln Q}{\partial \ln I}}}For discrete changes the elasticity is (using the arc elasticity) ϵ d = Δ Q Δ I × ( I 1 + I 2 ) / 2 ( Q 1 + Q 2 ) / 2 = Δ Q Δ I × I 1 + I 2 Q 1 + Q 2 , {\displaystyle \epsilon _{d}={\Delta Q \over \Delta I}\times {(I_{1}+I_{2})/2 \over (Q_{1}+Q_{2})/2}={\Delta Q \over \Delta I}\times {I_{1}+I_{2} \over Q_{1}+Q_{2}},}where subscripts 1 and 2 refer to values before and after the change. InterpretationThe most commonly used elasticity in economics, the price elasticity of demand, is almost always negative, but many goods have positive income elasticities, many have negative.
Income elasticity of demand can be used as an indicator of future consumption patterns and as a guide to firms' investment decisions. For example, the "selected income elasticities" below suggest that as incomes increase over time, an increasing portion of consumers' budgets will be devoted to purchasing automobiles and restaurant meals and a smaller share to tobacco and margarine.[1] Selected income elasticities
Income elasticities of demand for gasoline and diesel have been studied extensively, however, elasticities vary widely between studies. Estimates for income elasticities of demand for gasoline in developed economies range from 0.66 to 1.26.[10] Income elasticities and budget sharesBeing a normal good (elasticity > 0) means that with higher income, consumption of the good will rise, but it does not mean that the good's share of the consumer's budget will rise with income. That depends on whether the elasticity is below or above +1. If the elasticity is negative, such as margarine's -.20 (from the "Selected income elasticities" section of this article), then it is obvious that margarine's share of the consumer's budget will fall if his income rises 10%. If the elasticity is tobacco's +.42, however, an income increase of 10% generates a spending increase of 4.2%, so tobacco's share of the budget falls. His purchases of books, with an elasticity of +1.44, will rise 14.4%, however, and so will have a higher budget share after his income rises. In aggregate, food has an income elasticity of demand between zero and one, so expenditure increases with income, but not as fast as income does. This observation is known as Engel's law. Income elasticities are closely related to the population income distribution and the fraction of the product's sales attributable to buyers from different income brackets. When buyers in a certain income bracket get a pay raise, the income elasticity can be used to predict how much more the market will consume of that product. If the income share elasticity is defined as the negative percentage change in individuals given a percentage increase in income bracken the income-elasticity, after some computation, becomes the expected value of the income-share elasticity with respect to the income distribution of purchasers of the product. When the income distribution is described by a gamma distribution, the income elasticity is proportional to the percentage difference between the average income of the product's buyers and the average income of the population.[11] Income-varying elasticities of demandIncome elasticities can vary as household income changes, particularly in the case of goods and commodities such as food and energy.[6] At low levels of per capita income, elasticities of demand for food, energy, or other products can be high. As per capita income increases, however, income elasticities fall. At high levels, the marginal elasticities may go to zero, or even negative.[12] These differences can be observed by comparing countries at different income levels. For example, estimates of the income elasticity of cereals ranges from 0.62 in Tanzania to 0.47 in Georgia, 0.28 in Slovenia, and 0.05 in the United States.[13] The decline in elasticities as income increases is a form of Kuznet's curve. As economies industrialize and get wealthier, consumer demand changes. At low levels of income, demand for energy or other goods increases very rapidly. However, as income rises further, consumption requirements (e.g. for food or energy) are increasingly satisfied. In addition, consumption patterns shift toward services rather than goods, which require fewer commodities to produce. See also
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When a proportionate change in the income of a consumer increases the demand for a product is known as?
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