Business Economics Unit 2: Elasticity Of Demand Notes [FYUGP BCom 2nd Sem. Gauhati University]

 In this post, we have provided Gauhati University BCom 2nd Semester NEP FYUGP Business Economics Unit 2: Theory of Demand and Analysis CHAPTER 3: ELASTICITY OF DEMAND Notes  with most important questions and previous year questions (PYQs). Each question is answered perfectly to help you boost your preparation to the next level.

Must Visit: GU Business Economics Important Notes, Solution Main Page

UNIT 2: THEORY OF DEMAND AND ANALYSIS

CHAPTER 3: ELASTICITY OF DEMAND 

Short Answer Type Questions

1. Define Price Elasticity of Demand? (GU BCom 2017, 2019)
Answer: Price Elasticity of Demand (PED) refers to the degree of responsiveness of the quantity demanded of a good to a change in its price. It is measured as the percentage change in quantity demanded divided by the percentage change in price. Mathematically,
PED = (% Change in Quantity Demanded) / (% Change in Price)

2. Explain Perfectly Elastic Demand?
Answer: Perfectly Elastic Demand occurs when a slight change in price leads to an infinite change in quantity demanded. In this case, the demand curve is a horizontal straight line, indicating that consumers will only buy at a specific price, and any increase in price results in zero demand.

3. Define Perfectly Inelastic Demand?
Answer: Perfectly Inelastic Demand refers to a situation where the quantity demanded of a good remains unchanged regardless of changes in its price. The demand curve in this case is a vertical straight line, indicating that consumers will buy the same quantity at any price. The elasticity coefficient is zero (PED = 0).

4. Explain Unitary Elastic Demand?
Answer: Unitary Elastic Demand occurs when the percentage change in quantity demanded is exactly equal to the percentage change in price. In this case, the price elasticity of demand is equal to one (PED = 1), meaning total revenue remains unchanged with price changes.

5. Explain Less Elastic Demand?
Answer: Less Elastic Demand, also known as Inelastic Demand, occurs when the percentage change in quantity demanded is smaller than the percentage change in price. The elasticity coefficient lies between 0 and 1, indicating that consumers are less responsive to price changes. Essential goods like salt and medicines typically exhibit less elastic demand.

6. Explain Arc Method of Measuring Price Elasticity of Demand?
Answer: The Arc Method measures the price elasticity of demand between two points on a demand curve by using the average of initial and final values. The formula is:

PED = [(Q₂ - Q₁) / (Q₂ + Q₁)] ÷ [(P₂ - P₁) / (P₂ + P₁)]

where:

• Q₁ and Q₂ are initial and final quantities

• P₁ and P₂ are initial and final prices

This method provides a more accurate elasticity measure over a range rather than a single point.

7. Define Income Elasticity of Demand?
Answer: Income Elasticity of Demand (YED) measures the responsiveness of the quantity demanded of a good to a change in consumer income. It is calculated as:

YED = (% Change in Quantity Demanded) / (% Change in Income)

A positive YED indicates a normal good, while a negative YED indicates an inferior good.

8. Explain Negative Income Elasticity of Demand?
Answer: Negative Income Elasticity of Demand occurs when an increase in consumer income leads to a decrease in the quantity demanded of a good. This is typical for inferior goods, where consumers switch to superior substitutes as their income rises. For example, demand for low-quality food items may decrease as income increases.

9. Define Cross Elasticity of Demand?
Answer: Cross Elasticity of Demand (XED) measures the responsiveness of the quantity demanded of one good to a change in the price of another related good. It is calculated as:

XED = (% Change in Quantity Demanded of Good X) / (% Change in Price of Good Y)

XED helps analyze the relationship between substitutes and complementary goods.

10. Explain Positive Cross Elasticity of Demand?
Answer: Positive Cross Elasticity of Demand occurs when the quantity demanded of one good increases as the price of another good rises. This typically happens in the case of substitute goods. For example, if the price of coffee increases, the demand for tea (a substitute) may rise.

11. Define Negative Cross Elasticity of Demand?
Answer: Negative Cross Elasticity of Demand occurs when the quantity demanded of one good decreases as the price of another good rises. This happens in the case of complementary goods. For example, if the price of petrol increases, the demand for cars may decrease because they are used together.

Long Answer Type Questions

1. What is Price Elasticity of Demand? Explain its degrees and measurements.
Answer: Meaning of Price Elasticity of Demand:

Price Elasticity of Demand (PED) refers to the degree of responsiveness of quantity demanded to changes in the price of a good or service. It is calculated using the formula:

PED = %Change in Quantity Demanded/%Change in Price

PED helps businesses and policymakers understand how consumers react to price changes and make informed decisions regarding pricing strategies.

Degrees of Price Elasticity of Demand:

The degree of price elasticity varies based on consumer behavior:

i) Perfectly Elastic Demand (PED = ∞): A small price change leads to an infinite change in quantity demanded. The demand curve is a horizontal line.

ii) Highly Elastic Demand (PED > 1): A percentage change in price leads to a larger percentage change in quantity demanded. Luxury goods typically exhibit this behavior.

iii) Unitary Elastic Demand (PED = 1): The percentage change in price and quantity demanded is equal, meaning total revenue remains constant.

iv) Inelastic Demand (PED < 1): The percentage change in price is greater than the percentage change in quantity demanded. This is common for necessities like salt and medicines.

v) Perfectly Inelastic Demand (PED = 0): Quantity demanded remains unchanged regardless of price changes. The demand curve is a vertical line.

Methods of Measuring Price Elasticity of Demand:

i) Percentage or Proportional Method:

PED = %Change in Quantity Demanded/%Change in Price

ii) Total Revenue or Total Expenditure Method:

• If total revenue increases when price decreases, demand is elastic.

• If total revenue decreases when price decreases, demand is inelastic.

• If total revenue remains constant, demand is unitary elastic.

iii) Point Method (Geometric Method):

PED =Lower Segment of the Demand Curve/Upper Segment of the Demand Curve

iv) Arc Method: Measures elasticity between two points on a demand curve using the formula:

PED =Q2 - Q1)/(Q2 + Q1)/(P2 - P1)/(P2 + P1)

v) Expenditure Method: Compares total expenditure before and after price changes to determine elasticity.

2. Explain Price Elasticity of Demand. What are the types of Price Elasticity of Demand? (GU BCom 2015, 2019, 2024)
Answer: Meaning of Price Elasticity of Demand:

Price Elasticity of Demand (PED) measures how much the quantity demanded of a good responds to a change in its price. It is used to assess consumer behavior and pricing strategies.

Types of Price Elasticity of Demand:

i) Price Elasticity of Demand (PED): Measures the responsiveness of quantity demanded to price changes.

ii) Income Elasticity of Demand (YED): Measures the responsiveness of demand to changes in consumer income.

iii) Cross Elasticity of Demand (XED): Measures the responsiveness of demand for one good to changes in the price of another related good.

iv) Advertisement Elasticity of Demand: Measures the responsiveness of demand to changes in advertising expenditure.

v) Substitution Elasticity of Demand: Measures the responsiveness of demand when substitute goods become available.

3. What is the meaning of Elasticity of Demand? Give factors which determine the price elasticity of demand. (GU BCom 2017, 2019)
Answer: Meaning of Elasticity of Demand:

Elasticity of Demand refers to the degree of responsiveness of quantity demanded to changes in various economic factors such as price, income, and prices of related goods. The main types include:

• Price Elasticity of Demand (PED)

• Income Elasticity of Demand (YED)

• Cross Elasticity of Demand (XED)

Factors Determining Price Elasticity of Demand:

i) Nature of the Good: Necessities (e.g., food, medicine) have inelastic demand, while luxuries (e.g., cars, jewelry) have elastic demand.

ii) Availability of Substitutes: Goods with close substitutes (e.g., tea and coffee) have elastic demand, while those without substitutes (e.g., salt) have inelastic demand.

iii) Proportion of Income Spent: Goods that take up a large proportion of income (e.g., electronics) have higher elasticity, while low-cost goods (e.g., matchboxes) have lower elasticity.

iv) Time Period: In the short run, demand tends to be inelastic, but in the long run, consumers can find substitutes, making demand more elastic.

v) Habitual Consumption: Goods that are habitually consumed (e.g., cigarettes, alcohol) tend to have inelastic demand.

vi) Durability of Goods: Durable goods (e.g., cars, furniture) have more elastic demand as consumers can delay purchases, whereas perishable goods (e.g., vegetables, milk) have inelastic demand.

vii) Use of the Good: Goods with multiple uses (e.g., electricity) have elastic demand as a price change affects various uses.

viii) Complementary vs. Independent Goods: Complementary goods (e.g., petrol and cars) tend to have inelastic demand, while independent goods (e.g., books and shoes) are not affected by price changes of other products.

These factors help businesses and policymakers determine pricing strategies and understand consumer behavior.  

4. Outline the importance of Elasticity of Demand in economic theory. Give its degrees.
Answer: Importance of Elasticity of Demand in Economic Theory:

The concept of elasticity of demand is crucial in various economic fields, including pricing policies, taxation, business decisions, and government regulations. Its importance is outlined below:

i) Pricing Policy: Firms use price elasticity of demand to decide whether to increase or decrease prices to maximize revenue. If demand is elastic, lowering prices can increase total revenue, whereas if demand is inelastic, increasing prices can be beneficial.

ii) Taxation Policy: Governments impose higher taxes on goods with inelastic demand (e.g., petrol, alcohol, tobacco) as consumers continue to buy them despite price increases, ensuring stable tax revenue.

iii) Consumer Decision-Making: Consumers adjust their purchases based on price elasticity, switching to substitutes when the price of a good rises.

iv) International Trade: Countries with highly elastic export demand must be careful with pricing, as small price increases can reduce demand significantly, impacting export revenues.

v) Wage Determination: Elasticity of demand for labor determines wage levels. If labor demand is inelastic, wages can be increased without reducing employment significantly.

vi) Government Price Controls: Authorities regulate prices of essential goods (e.g., medicines, staple foods) where demand is inelastic, preventing exploitation.

vii) Agricultural Pricing Policy: Elasticity helps in stabilizing farm product prices. Agricultural goods often have inelastic demand, meaning surplus production can lead to price crashes.

Degrees of Elasticity of Demand:

i) Perfectly Elastic Demand (PED = ∞): A small price change leads to an infinite change in quantity demanded. The demand curve is a horizontal line.

ii) Highly Elastic Demand (PED > 1): The percentage change in quantity demanded is greater than the percentage change in price.

iii) Unitary Elastic Demand (PED = 1): The percentage change in price equals the percentage change in quantity demanded.

iv) Inelastic Demand (PED < 1): A percentage change in price leads to a smaller percentage change in quantity demanded.

v) Perfectly Inelastic Demand (PED = 0): Quantity demanded remains unchanged regardless of price changes. The demand curve is a vertical line.

5. Define the term Elasticity of Demand. What is the relation between elasticity of demand and the slope of the demand curve?
Answer: Definition of Elasticity of Demand:

Elasticity of Demand measures how much the quantity demanded of a good responds to changes in price, income, or prices of related goods. The main types of elasticity are:

• Price Elasticity of Demand (PED)

• Income Elasticity of Demand (YED)

• Cross Elasticity of Demand (XED)

Relation Between Elasticity of Demand and the Slope of the Demand Curve:

The slope of the demand curve and elasticity are related but not the same. The slope of the demand curve represents the absolute rate of change in price and quantity, while elasticity measures the percentage change.

i) Steeper Demand Curve: When the demand curve is steep, demand is inelastic, meaning quantity demanded does not change significantly with price changes.

ii) Flatter Demand Curve: When the demand curve is flatter, demand is elastic, meaning quantity demanded changes significantly with price changes.

iii) Perfectly Elastic Demand (Horizontal Curve): A perfectly elastic demand curve is horizontal, indicating infinite responsiveness to price changes.

iv) Perfectly Inelastic Demand (Vertical Curve): A perfectly inelastic demand curve is vertical, showing no response to price changes.

Mathematically, elasticity at a point on the demand curve is calculated as:

PED = dQ/dP

where is the slope of the demand curve. Thus, even if the slope is constant in a linear demand curve, elasticity varies along different points.

6. Discuss the determinants of Elasticity of Demand?
Answer: The price elasticity of demand depends on several factors that influence how consumers respond to price changes. The main determinants are:

i) Nature of the Good: Necessities (e.g., salt, rice, medicines) have inelastic demand because they are essential. Luxuries (e.g., cars, jewelry) have elastic demand as consumers can do without them.

ii) Availability of Substitutes: Goods with close substitutes (e.g., tea and coffee) have elastic demand. Goods without substitutes (e.g., salt) have inelastic demand.

iii) Proportion of Income Spent on the Good: If a good represents a large portion of income (e.g., cars, electronics), its demand is elastic. If a good represents a small portion (e.g., matchboxes), its demand is inelastic.

iv) Time Period: In the short run, demand is inelastic as consumers take time to adjust. In the long run, demand is elastic as consumers find substitutes or change consumption habits.

v) Habitual Consumption: Goods that become a habit (e.g., cigarettes, alcohol) have inelastic demand since consumers find it difficult to stop using them despite price increases.

vi) Durability of Goods: Durable goods (e.g., furniture, appliances) have elastic demand as consumers can postpone purchases. Perishable goods (e.g., vegetables, milk) have inelastic demand.

vii) Use of the Good: Goods with multiple uses (e.g., electricity, steel) have elastic demand since consumers can adjust usage based on price. Goods with single-use (e.g., newspapers) have inelastic demand.

viii) Complementary vs. Independent Goods: Complementary goods (e.g., petrol and cars) have inelastic demand since consumers cannot easily switch. Independent goods (e.g., books and shoes) have demand unaffected by price changes of other goods.

These factors help businesses and governments in price-setting, taxation, and economic planning.

7. Explain the Concept of Income Elasticity of Demand?
Answer: Concept of Income Elasticity of Demand: Income Elasticity of Demand (YED) measures the responsiveness of the quantity demanded of a good to changes in consumer income. It helps in understanding how demand for a product changes when consumers' income increases or decreases.

Formula for Income Elasticity of Demand:

YED = %Change in Quantity Demanded/%Change in Income

Types of Income Elasticity of Demand:

i) Positive Income Elasticity (YED > 0): Demand increases as income increases. Normal goods and luxury goods exhibit this behavior.

ii) Negative Income Elasticity (YED < 0): Demand decreases as income increases. Inferior goods, such as low-quality food items, show this characteristic.

iii) Zero Income Elasticity (YED = 0): Demand remains unchanged despite changes in income. Essential goods like salt and medicines fall under this category.

iv) Income Elastic Demand (YED > 1): Demand increases at a higher rate than income. Luxury goods, such as branded clothing and high-end electronics, show this behavior.

v) Income Inelastic Demand (0 < YED < 1): Demand increases at a lower rate than income. Basic goods such as milk and rice exhibit this nature.

Importance of Income Elasticity of Demand:

1. Helps businesses predict future demand based on income changes.

2. Assists policymakers in understanding economic growth impacts on different industries.

3. Guides firms in segmenting markets for luxury and necessity goods.

8. Explain the Concept of Cross Elasticity of Demand. (GU BCom 2013, 2015, 2017, 2019)
Answer: Concept of Cross Elasticity of Demand:

Cross Elasticity of Demand (XED) measures the responsiveness of the quantity demanded of one good to changes in the price of another related good. It is useful for analyzing the relationship between substitutes and complementary goods.

Formula for Cross Elasticity of Demand:

XED = %Change in Quantity Demanded of Good X/%Change in Price of Good Y

Types of Cross Elasticity of Demand:

i) Positive Cross Elasticity (XED > 0): Demand for one good increases as the price of another good increases. This occurs in substitute goods (e.g., tea and coffee).

ii) Negative Cross Elasticity (XED < 0): Demand for one good decreases as the price of another good increases. This happens in complementary goods (e.g., petrol and cars).

iii) Zero Cross Elasticity (XED = 0): There is no relationship between the two goods, meaning price changes in one do not affect the other (e.g., books and shoes).

Importance of Cross Elasticity of Demand:

1. Helps firms understand competitive pricing strategies.

2. Guides businesses in planning product substitutions and complementary pricing.

3. Aids government policies on taxation and regulation of essential goods.

8. A consumer spends ₹1,000 on a good at a price of ₹10. When its price falls by 20%, he spends ₹800. Calculate Elasticity of Demand (ED) using Percentage Method. (GU BCom 2024)
Answer:

Given Data:

Initial Price

Price Decrease = 20% → New Price

Initial Expenditure = ₹1,000 → Quantity Demanded

New Expenditure = ₹800 → Quantity Demanded

Using Percentage Method:

PED = %Change in Quantity Demanded/%Change in Price}}

%Change in Price = P2 - P1/P1 x 100 = (8 - 10)/10 x 100 = -20%

% Change in Quantity Demanded = (Q2 - Q1)/Q1 x 100 = (100 - 100)/100 x 100 = 0%

PED = 0%/-20% = 0%

Conclusion:

Since PED = 0, the demand for the good is perfectly inelastic, meaning quantity demanded does not change despite price changes.

9. Explain 'Total Expenditure Method' and 'Geometric Method' of Measuring Price Elasticity of Demand. (GU BCom 2024)
Answer: Total Expenditure Method:

The Total Expenditure (Total Revenue) Method was developed by Alfred Marshall to measure price elasticity by analyzing how total revenue (price × quantity) changes with price variations.

Rules of Total Expenditure Method:

i) Elastic Demand (PED > 1): If total expenditure increases when price decreases or vice versa, demand is elastic.

ii) Unitary Elastic Demand (PED = 1): If total expenditure remains unchanged when price changes, demand is unitary elastic.

iii) Inelastic Demand (PED < 1): If total expenditure decreases when price decreases or vice versa, demand is inelastic.

Example of Total Expenditure Method:

Price (₹)	Quantity Demanded	Total Expenditure (₹)	Elasticity Type
10	100	1,000	-
8	120	960	Inelastic (TE decreased)
6	150	900	Inelastic (TE decreased)

Since total expenditure decreases with a fall in price, demand is inelastic.

Geometric Method (Point Method):

The Geometric Method measures elasticity at a specific point on the demand curve. It is calculated as:

PED = Lower Segment of the Demand Curve/Upper Segment of the Demand Curve

Interpretation of the Geometric Method:

• If PED > 1, demand is elastic.

• If PED = 1, demand is unitary elastic.

• If PED < 1, demand is inelastic.

Example Using a Demand Curve:

PED = Distance from the lower point to the equilibrium point / Distance from the upper point to the equilibrium point

If a demand curve is divided into two equal parts, the midpoint has unitary elasticity (PED = The upper portion of the demand curve is elastic, while the lower portion is inelastic.

Conclusion:

• Total Expenditure Method provides an indirect way to measure elasticity by observing total revenue changes.

• Geometric Method offers a precise way to measure elasticity at a particular point on a linear demand curve.

Both methods help businesses, policymakers, and economists in making informed pricing and demand analysis decisions.

10. What is Price Elasticity of Demand? Explain Different Methods of Measurement of Price Elasticity of Demand. (GU BCom 2013, 2016, 2017)

Answer: Meaning of Price Elasticity of Demand: Price Elasticity of Demand (PED) measures the responsiveness of quantity demanded to changes in the price of a good. It helps businesses and policymakers understand how consumers react to price changes.

Formula for Price Elasticity of Demand:

PED =% Change in Quantity Demanded/%Change in Price

Types of Price Elasticity of Demand:

i) Perfectly Elastic Demand (PED = ∞): A small price change causes an infinite change in quantity demanded. The demand curve is a horizontal line.

ii) Elastic Demand (PED > 1): A percentage change in price leads to a larger percentage change in quantity demanded.

iii) Unitary Elastic Demand (PED = 1): A percentage change in price leads to an equal percentage change in quantity demanded.

iv) Inelastic Demand (PED < 1): A percentage change in price leads to a smaller percentage change in quantity demanded.

v) Perfectly Inelastic Demand (PED = 0): Quantity demanded remains constant despite price changes. The demand curve is a vertical line.

Methods of Measuring Price Elasticity of Demand:

There are several methods to calculate price elasticity of demand:

1. Percentage Method (Proportional Method)

This method measures elasticity as the percentage change in quantity demanded divided by the percentage change in price.

PED = % Change in Quantity Demanded/%Change in Price

Example: If the price of a product decreases from ₹10 to ₹8 (20% decrease), and demand increases from 100 units to 150 units (50% increase), then:

PED = 50%/20%= 2.5

Since PED > 1, demand is elastic.

2. Total Expenditure (Total Revenue) Method

Developed by Alfred Marshall, this method examines how total revenue (price × quantity) changes when price changes.

Rules for Total Expenditure Method:

i) Elastic Demand (PED > 1): If total expenditure increases when price decreases (or vice versa), demand is elastic.

ii) Unitary Elastic Demand (PED = 1): If total expenditure remains unchanged when price changes, demand is unitary elastic.

iii) Inelastic Demand (PED < 1): If total expenditure decreases when price decreases (or vice versa), demand is inelastic.

Price (₹)	Quantity Demanded	Total Expenditure (₹)	Elasticity Type
10	100	1,000	-
8	120	960	Inelastic (TE decreased)
6	150	900	Inelastic (TE decreased)

Since total expenditure decreases with a fall in price, demand is inelastic.

3. Point (Geometric) Method

The Geometric Method is used to measure elasticity at a specific point on the demand curve.

PED = Lower Segment of the Demand Curve/Upper Segment of the Demand Curve

If a straight-line demand curve is divided into two equal parts, the midpoint has unitary elasticity (PED = 1). The upper portion of the demand curve is elastic, while the lower portion is inelastic.

4. Arc Method: The Arc Method calculates elasticity between two points on a demand curve, considering the average price and quantity.

Example:

If price decreases from ₹10 to ₹8 and quantity demanded increases from 100 to 120, then:

Since PED < 1, demand is inelastic.

Conclusion:

• The Percentage Method provides a simple formula-based approach.

• The Total Expenditure Method helps analyze elasticity by looking at revenue changes.

• The Point Method is useful for precise calculations at a specific point.

• The Arc Method is helpful for measuring elasticity over a range.

Each method has its advantages, and the choice depends on the available data and the specific analysis required.

-0000-

Must Visit: Gauhati University FYUGP BCom 2nd Sem Main Page