CHAPTER
3.4
3.5
3.6
3.7
3.8
3.9
5.4
6.8
6.9
6.10
9.3 Assumptions of Ordinal Utility Approach
9.4 Indifference Map
9.5 Properties of Indifference Curve
9.6 Good, Bad and Neuter
CHAPTER 10
MARGINAL RATE OF SUBSTITUTION: SHAPES OF INDIFFERENCE CURVE AND BUDGET LINE
10.1 Different Possible Shapes of Indifference Curves
10.2 Exceptions
10.3
10.5
CHAPTER 11
CHAPTER 12
INCOME EFFECT : INCOME CONSUMPTION CURVE AND ENGELS CURVE
12.1 Income Effect
12.2 Effect of Change in Income on the Demand curve in case of Normal goods
12.3 Effect of Change in Income on Demand Curve in case of Inferior Good or Derivation of Demand Curve
12.4 Engels curve
12.5 Slope of Engels Curve
12.6 Derivation of demand curve with the help of Engels curve
14.1
14.3
14.4
CHAPTER 13
CHAPTER 14
EFFECT
CHAPTER 15
DECOMPOSITION OF PRICE EFFECT INTO INCOME AND SUBSTITUTION EFFECT: HICKSIAN APPROACH
15.1
15.3
15.4
15.5
15.6
15.7
15.8
CHAPTER 16
APPLICATIONS OF INDIFFERENCE CURVE
16.1
CHAPTER 17
NUMERICALS ON INDIFFERENCE CURVE
17.1 Numericals 155
CHAPTER 18
PRODUCTION DECISIONS OF FIRMS IN SHORT RUN
18.1 Introduction 162
18.2 Law of Diminishing Marginal Returns/Law of Variable Proportion 163
18.3 Stage of Operation 166
18.4 Case Study 168
18.5 Questions for Review 169
CHAPTER 19
ISOQUANTS
19.1 Introduction
19.2 Isoquants 173
19.3 Marginal Rate of Technical Substitution 174
19.4 Two special cases: Substitute and Complementary Goods 175
19.5 Ridge lines or Economic region 178
19.6 Questions for Review 179
19.7 Numericals on Isoquant 180
CHAPTER 20
PRODUCTION DECISION OF FIRMS IN THE LONG RUN
20.1 Introduction 183
20.2 Pro t maximisation and Cost minimisation (Least cost combination) 183
20.3 Long run Equilibrium of the Firm 185
20.4 Equilibrium of Firm in Long Run/Producer’s Equilibrium 186
20.5 Expansion Path or Product Line 190
20.6 Questions for Review 191
20.7 Numericals on Producer’s Equilibrium 192
21.1
21.2
21.4
CHAPTER 21
ECONOMIES AND DISECONOMIES OF SCALE
CHAPTER 22
LONG RUN LAW OF PRODUCTION: RETURNS TO SCALE
22.1
22.2 Returns to Scale: Without the Help of Isoquants
22.3 Returns to Scale: With the Help of Isoquants
22.4 Factors Responsible for Returns to Scale
22.5 Comparison of Returns to Variable Factor and Returns to Scale
22.6 Difference between Diminishing Returns to a factor and Diminishing Returns to scale
22.7
22.9
CHAPTER 23
COST CURVE IN THE SHORT RUN
23.1
23.9
CHAPTER
DERIVATION OF LONG RUN COST CURVES
24.1 Difference between Nature of Short Run and Long Run Total Cost
24.2 Derivation of Long Run Average Cost Curve
24.3 Derivation of Long Run Marginal Cost
24.4 Shape of Long Run Average Cost under Different Cost Conditions
24.5 Relation between Long Run Average Cost and Marginal Cost
24.6 Cost-output Elasticity
24.7 Case Study: Shape of LAC in case of CRS, IRS and DRS
24.8
24.9
CHAPTER
25.3
25.4
25.5
CHAPTER
26.1
26.2
26.4
26.5
CHAPTER
27.1
CHAPTER 28
SUPPLY CURVE OF FIRM AND INDUSTRY UNDER PERFECT COMPETITION
28.1 Supply Curves for a price-taking rm
28.2 Supply Curve of the Industry in the Short Run
28.3 Long run Industry Supply Curve
28.4 Allocative ef ciency under Perfect Competition
28.5
CHAPTER 29
MONOPOLY
29.1
29.3
29.4
29.5 Monopolist
29.6 Rules of Thumb of
29.7 Learner’s Measure of Monopoly
29.8 Determinants of Monopoly
29.9
29.10
29.11
CHAPTER 30
PROFIT MAXIMISATION UNDER MONOPOLY: CHOOSING OUTPUT IN THE SHORT RUN & LONG RUN
30.1 Pro t Maximisation: Short Run & Long Run
30.2 Long Run Equilibrium under Monopoly
30.3 Dead Weight Loss
30.4 Questions for
CHAPTER 31
31.2
CHAPTER 32
COMPETITION
32.1
32.2
32.3
32.4
32.5
32.6
CHAPTER 33
OLIGOPOLY
33.1
33.2
33.3 Features/Characteristics of Oligopoly
33.4 Equilibrium in Oligopolistic
33.5 Cournot’s
33.6
33.7 Price Rigidity—Sweezy’s
33.8
33.9
33.10
33.11
34.7
34.8
34.9
Elasticity of Demand and Supply
PRICE ELASTICITY OF ALCOHOL DEMAND IN INDIA
Using a household survey conducted in 2014, this study estimates price elasticity of demand for beer, country liquor and spirits in India. Alcohol prices are negatively associated with demand for alcoholic beverages. The price elasticity of demand ranged from –0.14 for spirits to –0.46 for country liquor. Low level of education was positively associated with spirits consumption. The magnitude of elasticity varied by rural-urban, education and gender. Results indicate a policy mix of price controls and awareness campaigns would be most effective in tackling the adverse effects of harmful drinking in India.
Source: Kumar, S. (2016). “Price Elasticity of Alcohol Demand in India,” Working Papers 1610, Sam Houston State University, Department of Economics and International Business.
6.1 Introduction
Demand curve shows the effect of the change in price of a good on the quantity demanded. But it does not show the extent to which demand changes in response to change in price. This is shown with the help of elasticity of demand. Elasticity is denoted by lower-case Greek letter eta (
6.2 Types of Demand Elasticities
6.3 Price Elasticity of Demand
It refers to the responsiveness of change in quantity demanded due to one per cent change in its price.
or = Percentage change in quantity demanded Percentage change in price = Q Q P P = Q Q × P P = Q P P Q ...... 1
Equation 1 is split in two parts: (i) Q P (ii) P Q
Where:
(i) Reciprocal of Q P measures the slope of the demand curve.
(ii) P Q is the level of price and quantity at which we make our measurement.
6.4 Different ways of Measuring Elasticity
Total Expenditure Method Point Method Arc Method Methods
6.5 Total Expenditure Method
(Total Outlay method or Total Revenue method:)
(Relationship between Elasticity and Total Spending)—given by Alfred Marshall
Total Expenditure (TE) of a consumer is equal to price of the product (P) times number of units bought (Q)
TE = P.Q
Total amount spent by the consumer is the gross revenue of the sellers, therefore, it is also called total revenue method.
If price of a commodity falls, quantity demanded will rise. However, the total revenue will depend on the amount by which the sales rises in response to fall in price e.g. Assume there are 3 consumers - A, B, C.
If price of pen fall from Rs. 4.00 to Rs. 2.00, although the demand of pen by all consumers will increase, but the response of the consumers will vary.
Thus regardless of the shape of demand curve as the price of commodity falls, total expenditure rises when e > 1; remains unchanged when e = 1 and falls when e < 1.
Relation between price and TE
P TE
There is inverse relationship between P and TE
> 1 demand is elastic (Fig. a)
Quantity effect outweighs the price effect, because more is spent when price falls. In other words small decrease in price leads to very large increase on Quantity. As a result Quantity effect dominates and revenue rises.
= 1 unit elastic (Fig. c)
When P TE There is direct relationship between P and TE < 1
demand is inelastic (Fig. b)
Price effect outweighs the quantity effect. Less is spent when price falls.
6.5-1 Point Method
It is a geometrical way of measuring elasticity at a particular point on the demand curve.
Lower segment of the demand curve
η = Upper segment of the demand curve
(Fig. 6.1)
at point R = RB RA RB = RA = 1
at point S = SB SA SB < SA < 1
at point T = TB TA TB > TA > 1
at point B = O AB = O = 0
at point A = AB O = =
6.5-2 Arc Method
FIG. 6.1: POINT METHOD
Point method measures elasticity only at a particular point on the demand curve. To measure the elasticity between two different points on the demand curve arc method is used. The coefficient of price elasticity between two points on a demand curve is called arc elasticity.
Arc method is an average method. It is the best approximate to the correct measure, when measured between two separate points on a demand curve. It is obtained by defining price and quantity as the average of prices and quantities at two points on the curve Source: Lipsey and Chrystal Elasticity between two points that is, midway between A and B: (Fig. 6.2)
∆Q = Q0Q1
∆P = P0P1
P = (P0 + P1)/2
Q = (Q0 + Q1)/2
= Q P × (P0 + P1)/2 (Q0 + Q1)/2
= Q0Q1
P0P1 × (P0 + P1)/2 (Q0 + Q1)/2
= Difference in quantity Difference in price × Sum of prices Sum of quantities
6.2: ARC
Percentage method gives different answer for elasticity at any point on a nonlinear demand curve, especially while finding elasticity on a unit elastic curve, therefore, arc method is used. (a) (b) (c)
According to total outlay method = 1 box a
But, according to percentage method > 1 box b
according to arc method = 1 box c
Thus, percentage method gives solution which is unsatisfactory, that is why to avoid the problem arc method is used while calculating elasticity.
6.6 Measure Elasticity on a Non-Linear Demand Curve (For Understanding)
Elasticity at any one point on a non-linear demand curve is not same as at other points because ∆Q/∆P varies with the direction and magnitude of the change in price and quantity.
To measure the elasticity at any point, a tangent is drawn on the demand curve at that point.
The slope of the tangent to the demand curve which is the reciprocal of ∆Q/∆P measures the value of elasticity at that point e.g., point A (Fig. 6.2).
Elasticity at point A = Slope of tangent ‘T’ = P Q (Fig. 6.3)
∆P > ∆Q > 1
at point B = slope of tangent ‘T1’ = P1 Q1
∆P1 < ∆Q1 < 1
FIG. 6.3: ELASTICITY BY EXACT METHOD
Similarly at point C is found out at point C = 1
6.7 Measuring Elasticity on a Linear Demand Curve
Although elasticity is not the same as the slope of the demand curve, slope is one of the determinants of elasticity.
At a given price or quantity, flatter demand curve have higher elasticity than steeper ones.
55 MEASURING ELASTICITY ON A LINEAR DEMAND CURVE Para 6.7
In case of a linear demand curve, elasticity varies from zero to infinity. It can be explained alternatively by either of the 2 approaches:
(1) with help of P/Q ratio
(2) with help of Point Method: = lower segment upper segment
Since a straight line has constant slope, therefore, the ratio ∆P/∆Q, that is, the reciprocal of ∆Q/∆P is same at all points on the curve.
Thus elasticity at different points on the curve is found with the help of ratio P Q
As we move down the demand curve, ratio P Q falls and thus elasticity falls.
Method
FIG. 6.4: ELASTICITY ON LINEAR DEMAND CURVE
Fig. 6.4 1st Approach
(i) At price axis, i.e., at point A: Q = 0 P Q = P O = undefined =
(ii) At quantity axis, i.e., at point B: P = 0 P Q = O Q = 0
(iii) As we move down the demand curve:
e.g. at point F P falls and Q rises steadily
Ratio P Q falls Thus < 1
(iv) As we move up the demand curve:
e.g. at point C P rises and Q falls
Ratio P Q rises > 1
(v) On the middle point of demand curve:
e.g. at point E: Ratio P Q is equal = 1
B
FIG. 6.5: Quantity
Alternative approach Fig. 6.5
At point A when Q = 0 AB O
At point B when P = 0 O AB 0
At point F: FB FA FB < FA
At point C: CB CA CB > CA
At point E: EB EA EB = EA
6.8 Degrees of Price Elasticity
Interpreting price elasticity:
The value of price elasticity of demand ranges from zero to minus infinity.
6.8-1 Case I. Elasticity is Zero: = 0: Perfectly Inelastic
Quantity demanded does not respond to a change in price, that is, whether price increases or decreases, quantity demanded remains constant. (e.g salt) Necessities
The demand curve will be vertical straight line parallel to Y - axis (Fig. 6.6.1)
Such a demand curve is called Perfectly or Completely Inelastic
FIG. 6.6.1: PERFECTLY INELASTIC DEMAND
6.8-2 Case II. Elasticity is infinity: = : Perfectly elastic
At a given price (OP) (Fig. 6.6.2) any amount of quantity is demanded. Slight change in price will lead to an infinite change in quantity demanded. There is complete substitution away from that good towards something else. e.g. Luxury goods
Such a demand curve is called Perfectly elastic
6.8-3 Case III. Elasticity in one: = 1: Unit elastic
FIG. 6.6.2: PERFECTLY ELASTIC DEMAND
FIG. 6.6.3: UNIT ELASTIC DEMAND
Percentage change in quantity demanded is equal to percentage change in price (Fig. 6.6.3a) ∆Q = ∆P
Such a curve is called a rectangular hyperbola (Fig. 6.6.3b) for which price time quantity, (P × Q) is constant at all points on the curve.
6.8-4 Case IV. Elastic demand > 1
Percentage change in quantity demanded is greater than percentage change in price (Fig. 6.6.4).
∆Q > ∆P
The demand curve will be flatter.
It implies ceteris paribus, less is the change in price and greater is the change in quantity demanded.
6.8-5 Case V. Inelastic demand: < 1
Percentage change in quantity demanded is less than percentage change in price (Fig. 6.6.5)
∆Q < ∆P
The demand curve will be steeper
It implies ceteris paribus, greater is the change in price lesser will be the change in quantity demanded:
6.8-6 In case of Constant Elasticity : Extreme Cases of Elasticity (i) = 0 (ii) = 1 (iii) = ∞ (i) η = 0 (ii) η = 1 (iii) η = ∞
FIG. 6.6.4: ELASTIC GREATER THAN ONE
FIG. 6.6.5: ELASTICITY LESS THAN ONE
FIG. 6.6.6: THREE CONSTANT-ELASTICITY DEMAND CURVES
In (Fig. 6.6.6) each curve has a constant elasticity.
6.9 Determinants
of Elasticity of Demand/Factors on which Elasticity of Demand depends
I. Availability of substitute: It is the main determinant of elasticity. If close substitutes are available - demand will be more elastic
If substitutes are not available - demand will be more inelastic, that is goods which have poor and few substitutes e.g. food will have low price elasticities.
Reason: When price of product changes, with price of substitutes remaining constant, consumer will substitute one product for another.
For e.g. when price of tea falls consumers will buy more of tea and less of its substitute, that is, coffee. Therefore coefficient of price elasticity is very high.
On the other hand, salt has no good substitute therefore its elasticity is very low.
II. Nature of the product or Definition of the product:
In case of necessities: Demand will be more inelastic.
Reason: No substitutes are available e.g. food.
In case of durable goods: Demand will be more elastic e.g., cooler, computers etc.
Reason: Most of the goods have close substitutes.
III. Adjustment time:
In short run: demand will be more inelastic, that is, less elastic
In long run: demand will be more elastic
e.g. petrol. In short run when price of petrol rises, there will be some fall in quantity demanded, but the percentage fall in demand will be less than percentage rise in price. This is because it takes time for consumers to find new products and new prices.
Over time, in the long run some alternative source will be developed like factories will switch over to relatively cheaper source of power and thus in long run percentage fall in demand will be greater than percentage rise in price.
IV. Expenditure on the commodity: Greater the percentage of income spent on commodity greater is its elasticity e.g. Demand for computer is more elastic than of needles, buttons etc.
V. Price level: If the price is towards the upper end of the demand curve it is more elastic than it is towards lower end.
VI. Related products: Any one group of related product will have more elastic demand but, demand for the group of related product as a whole will be more inelastic e.g., pen has more elastic demand but all stationery taken together have more inelastic demand.
VII. Number of uses of the commodity: Greater the number of uses of a commodity, greater will be the elasticity e.g. elasticity of coal is greater than elasticity of milk because milk is used only as food but coal has number of uses e.g. in factory, railways etc.
6.10 Importance of Elasticity of Demand
The concept of price elasticity of demand assumes great significance theoretically as well as practically. Its various applications have been discussed as follows:
Fixation of Price: The policies regarding fixation of price by the producers are framed by them keeping in mind the price elasticity for the product and its related goods. They tend to set a high price of the commodity if the demand for the commodity is inelastic as it will fetch them greater revenue. However, the benefits of raising price can be attained only if the commodity has poor or no substitutes else raising price will cause a shift of consumption from the commodity to its substitute.
Importance to a Monopolist: A knowledge of price elasticity of demand for commodity by different consumers will be beneficial to a monopolist if he practices price discrimination1. He will charge a high price from consumers whose demand is inelastic and a low price from consumers who have an elastic demand for the commodity.
Wage Bargaining: The argument cited above holds good in the factor market as well, precisely for the price of labour i.e. the wage rate. High wage rates are demanded by trade unions if the demand for labour is low or inelastic. However, if the demand for labour is elastic, trade unions can’t bargain for a higher wage rate as higher wages cause an increase in the cost of production thereby causing a fall in the demand for the commodity resulting in the decrease in demand for labour i.e. unemployment of labour.
Determination of the Terms of Trade: For trade relations to exist between two countries, the terms of trade are determined by the reciprocal elasticities of demand of the two countries for each other’s goods.
Indirect Taxation: The government makes use of the concept of price elasticity of demand while fixing the rate of indirect tax, like sales tax, excise duties etc. An imposition of tax causes the price of the commodity to rise. If the demand for the commodity is elastic, a rise in price of the commodity due to taxation will result in a fall in the quantity demanded of the commodity leading to a decline in the revenue obtained by the government. Therefore, if the objective of the government is to obtain higher revenue, it imposes taxes on the commodities whose demand is inelastic.
Incidence of Taxation: ‘Incidence of taxes refers to the people who ultimately bear the burden of taxes.’ The incidence of taxes lies on whom, the buyers or the sellers, is determined by the elasticity of demand as given below:
1. Price discrimination is the practice of charging different price of the commodity from different consumers in different markets on the basis of elasticity of demand.
