EABD Notes For Chapter 2
Elasticity Of Demand
• Concept by Cournot and mill, developed by Dr. Alfred marshal
• Elasticity means responsiveness of one variable to variation of another
• Elasticity of demand means responsiveness of quantity demanded to the change in price,
income and price of related goods
• Two variable: - demand(dependent) and determinants of demand (independent and
measurable like price)
• Types:- price, income and cross elasticity
• Price Elasticity of demand = % change in quantity
% change in price
➢ Types of price elasticity of demand
1. Perfectly elastic demand (where price is constant and graph is parallel to X axis)
2. Perfectly inelastic (where Quantity is constant and graph is parallel to Y axis)
3. Relatively elastic demand (change in quantity is more than change in price, Ep>1)
4. Relatively inelastic demand (change in price is more than change in quantity, Ep<1)
5. Unit elasticity of demand (change in quantity is equal to change in price, Ep=1)
• Income elasticity of demand = % change in quantity ( normally positive)
% change in income
➢ Types of income elasticity of demand
1. Negative income elasticity (where demand increase and income decrease)
2. Zero income elasticity (where Quantity is constant and graph is parallel to Y axis)
3. Unit income elasticity (where demand and income increase simultaneously,
demand = income)
4. Low-income elasticity (where change in quantity is more than income)
5. High income elasticity (where change in quantity is low than income)
• Cross elasticity of demand = % change in quantity of X
% change in price of Y
• Substitute:- A rise in the price of Good S leads to a small rise in the demand for good T then
they are said to substitute of each other, for example:- shampoo and conditioner
• Complements:- A fall in the price of good X leads to a large rise in the demand for good Y,
For example:- Petrol and Petrol Car
• Zero cross elasticity:- A fall in the price of good A leads to no change in the demand for
good B, for example:- iPhone and Other Mobile phones
Economics of demand
• Demand analysis explain the law of demand and interpret demand schedule
• Demand indicates how much of a product consumer willing and able to buy at given price
• Demand function is a relation between quantity demanded and factors influence it
• Law of demand says that higher the price, the smaller the quantity demanded
• A change in price causes movement along the demand curve (also called Variation in
demand)
• A change in one of the determinants of demand other than price causes Shift of demand
curve (also called change in demand)
• A Giffen good is a low income, non-luxury product for which demand increases as the
price increases and vice versa
• Veblen goods are typically high-quality goods that are made well, are exclusive, and are a
status symbol
• A normal good is a good that experiences an increase in its demand due to a rise in
consumers' income
• "Inferior good" is an economic term that refers to an item that becomes less desirable as
the income of consumers increases
➢ DETERMINANTS OF DEMAND
• Price of the product
• Income level of the consumer
• Price of substitutes or complementary
• Tastes and preferences of consumer
• Expectations about the prices in future
• Expectations about income in future
• Number of consumers
• Advertising effort
• Provision of social security
Demand Estimation: - To know about the probable demand for a product in current situation
demand estimation is used
Demand forecasting: - To know about the probable demand for a product in a days to come, a
demand forecasting is carried out
Factors governing demand forecast:-
➢ Types of forecasts
➢ Forecasting level
➢ Established or new product
➢ Types of goods
➢ Degree of competition
Subjective/Qualitative Forecasting
➢ Interview and survey approach
➢ Statistical method
1. Trend projection (draw trendline for forecasting)
2. Simple moving average (last number of averages of previous data)
3. Scatter plots & correlation
➢ Test marketing
Correlation: - determines co-relationship or association of two variables
Regression: - describes how an independent variable is numerically related to dependant variable
Theory of consumer behaviour
• Cardinal utility approach Propounded by Marshall and also known as marshalling
approach
• Ordinal utility approach Propounded by Hicks & Allen and also knowns as
Indifference curve analysis
• Utility → “WANT SATISFYING POWER” of a Commodity.
• Features of utility: - Subjective, relative, ethically neutral, not essential useful
1. Initial Utility: - Utility Derived from the Consumption of Ist Unit
2. Total Utility: - utility derived by the consumer from all units of a commodity
consumed
3. Marginal Utility: - change in total utility resulting from change in last
consumption
• Types of marginal utility: -
1. Positive marginal utility: -consumption of an additional unit, total utility
increase
2. Zero marginal utility: - consumption of an additional unit, total utility remain
constant
3. Negative marginal utility: - consumption of an additional unit, total utility
decrease
• Marginal Utility Analysis: - Formulated by Alfred Marshall, Theory Explains How a
Consumer spends his Income on Different Goods & Services so as to attain Maximum
Satisfaction
• Law of diminishing marginal utility: - as the amount of a good increases, the marginal
utility of the good tends to decrease – samuelson
• For example: - if we increase consumption of Tea by no. of cups , our marginal utility for
next cup of tea will decrease
• Marshallian Consumer ’s Surplus : - What a Consumer is Willing to Pay – What he
Actually Pays
• Marginal Rate of Substitution :- The Rate at which an Individual must give up “Good A” in
order to obtain One More Unit of “Good B ”, while keeping their Overall Utility
(Satisfaction) Constant.