Theory of Demand Questions and Answers AP Inter 1st Year Economics Chapter 3

Andhra Pradesh BIEAP AP Inter 1st Year Economics Study Material 3rd Lesson Theory of Demand Class 11 Textbook Exercise Questions and Answers.

Theory of Demand Class 11 Questions and Answers AP Inter 1st Year Economics 3rd Lesson

I. Multiple Choice Questions (1 Mark)

Question 1.
Demand for a commodity refers to:
(1) Ability to purchase the commodity
(2) Willingness to pay the price of the commodity
(3) Desire for the commodity
(4) Demand is always measured per unit of time
(1) 1 and 2
(2) 2 and 3
(3) 1 and 3
(4) all of the above
Answer:
(4) all of the above

Question 2.
The law of demand can be derived with the help of which of the following principles ?
(1) The law of diminishing marginal utility
(2) The law of equi marginal utility
(3) The law of diminishing returns
(4) The law of supply
Answer:
(1) The law of diminishing marginal utility

Question 3.
A rightward shift in the demand curve is the result of:
(1) An increase in the price of a complementary good
(2) A fall in the price of a substitute good
(3) An increase in the price of a substitute good
(4) A fall in the price of a commodity
Answer:
(3) An increase in the price of a substitute good

Question 4.
Price elasticity of demand refers to the:
(1) Responsiveness of price to a change in demand
(2) Responsiveness of demand to a change in price
(3) Responsiveness of demand to a change in income
(4) Responsiveness of demand to a change in prices of related goods
Answer:
(2) Responsiveness of demand to a change in price

Question 5.
As a result of a rise in the price of onions from Rs. 30 per kg to Rs. 70 per kg, the quantity demanded decreases from 7 kg per week to 3 kg per week. Calculate the price elasticity of demand by using the Arc method.
(1) 0.71
(2) 1.0
(3) 1.71
(4) 1.25
Answer:
(2) 1.0

II. Fill in the Blanks (1 Mark)

Question 1.
The Veblen effect and the substitution effect are ……………. to the law.
Answer:
Exceptions

Question 2.
If coffee and tea are substitute goods, a rise in the price of coffee will lead to a/an ……………. in the demand for tea.
Answer:
Increase (rise

Question 3.
When total expenditure decreases with a fall in price and increases with a rise in price, the elasticity of demand is said to be …………….. .
Answer:
Inelastic

Question 4.
If the price falls, demand increases because of the increase in
Answer:
Real income (or) Purchasing power

Question 5.
In the long run, the demand for a product will be …………… because of the availability of substitutes.
Answer:
Elastic

III. Answer the following questions in one word. (1 Mark)

Question 1.
What type of relationship exists between price and quantity demanded ?
Answer:
Inverse (Negative)

Question 2.
What is the combined effect of the income effect and the substitution effect ?
Answer:
Price Effect

Question 3.
What formula measures elasticity at any point on a downward sloping linear demand curve ?
Answer:
Lower segment ÷ Upper segment

Question 4.
What is the value of elasticity of demand, if the price of a good falls from Rs. 10 to Rs. 8, and the quantity demanded increases from 100 units to 150 units?
Answer:
– 2.5 (or) 2.5

Question 5.
Which type of elastic goods are taxed by the finance minister ?
Answer:
Inelastic (E_d < 1)

IV. Briefly explain the following concepts in two to three sentences. (2 Marks)

Question 1.
Demand Function
Answer:
Price demand explains the relationship between price and quantity demanded of a commodity. Price demand states that there is an inverse or negative relationship between price and quantity demanded of a commodity at a given point of time.

According to Alfred Marshall, the law of demand states, that “The amount demanded increases with a fall in price and diminishes with a rise in price when other things remain the same”.

Question 2.
Demand function
Answer:
Demand function is a mathematical expression that shows the relationship between the quantity demanded of a commodity and the factors that determine it.
It is expressed as follows,
D_x = f(P_x, P_r, Y, T, 0)
Where; D_x = Demand for good X, P_x = Price of good X, P_r = Prices of related goods (Substitutes or Complements), Y = Income of the consumer, T = Tastes and preferences of the consumer, 0 = Other factors, f = Functional relationship
Here, demand is the dependent variable, while price, income, tastes of the consumer are considered independent variables.

Question 3.
Giffen paradox
Answer:
Sir Robert Giffen (1837-1910) observed that poor people will demand more of nec-essary goods with no close substitutes when their prices rise. He observed that when the price of bread increased, workers in England purchased more bread, by reducing their consumption of meat, the price of which remained constant. It is because bread is a basic necessity where as meat is not a close substitute.

Similarly, when price of inferior goods such as ragi, jowar, bajra, broken rice etc., falls, consumer buys less of them. It is because, with the fall of price, his real income increases. He prefers to substitute superior good in place of inferior good. Such inferior goods are called Giffen goods and the paradox is called Giffen’s paradox.

Question 4.
Veblen effect
Answer:
Veblen pointed that there are some goods like diamonds, precious stones, costly furniture etc., which are demanded by very rich people for their social prestige.

If the prices of these goods fall, poor people also can buy. Hence, rich people may stop buying these goods after a fall in price as they no longer carry a special status. Such goods are called Veblen goods.
Thus, in the case of Veblen goods there exists a positive relationship between price and quantity demanded which is contrary to the law of demand.

Question 5.
Income effect
Answer:
When the price of a commodity falls, the consumer’s real income increases. The consumer can buy the same quantity of the commodity with less money or buy more of the same commodity with the money that becomes available for additional purchase. This leads to a rise in consumer’s real income (purchasing power), and thus demand for that commodity (whose price has fallen) increases. This is called the “income effect”.

Question 6.
Substitution effect
Answer:
when the price of a commodity falls, it becomes relatively cheaper than its substitutes. People will substitute cheaper goods for dearer goods. So, demand increases. This is called “substitution effect”.
For example, when the price of tea falls, it becomes relatively cheaper than coffee, and people start substituting tea for coffee.

Question 7.
Income demand
Answer:
Income demand explains the relationship between a consumer’s income and various quantities of goods and services demanded at various levels of income, assuming that other factors remain constant.
These factors include the price of the good, the price of related goods, tastes, preferences, etc.

Question 8.
Demand curve for substitutes
Substitutes are goods that satisfy the same want. For example, tea and coffee, pepsi and coca-cola etc. There is an positive relationship between price and demand in case of Substitute goods. If the price of coffee decreases, while the price of tea remains constant, then the demand for tea decreases, especially if the existing price of tea is higher than the new price of coffee.

In such cases, consumers shift their demand from tea to coffee. Similarly, if the price of coffee increases, while the price of tea remains constant, the demand for tea increases. Hence, in the case of substitutes, the demand curve has a positive slope i.e., it slopes upward from left to right.

In the Diagram, the OY-axis represents the price of coffee and the OX-axis represents the demand for tea.
An increase in the price of coffee from OP to OP₂ leads to an increase in the demand for tea from OQ to OQ₂.
Hence, in the case of substitute goods the demand curve slopes upward from left to right.

Question 9.
Price Demand curve for complementary goods
Answer:
Complementary goods are those goods that satisfy the same want jointly. For instance, cars and fuel, shoes and socks, bread and butter, lock and key etc.

There is an inverse relationship between price and demand in case of Complementary goods. The demand curve for complementaries slopes downward. Example: If the price of fuel decreases, the demand for cars increases, with the prices of cars remaining constant.

• In Diagram, the price of fuel is shown on the OY-axis and the demand for cars is shown on the OX-axis.
• If the price of fuel decreases from OP to OP₂ the demand for cars may increase from OQ to OQ₂ and vice versa.
• Thus the cross demand curve for complementaries slopes downward.

Question 10.
Perfectly elastic demand
Answer:
Perfectly elastic demand is also known as ‘infinite elastic demand’.
If a small change in price causes an infinite change in quantity demanded, it is known as perfectly elastic demand. This means the quantity demanded of the commodity is perfectly flexible in the case of perfectly elastic demand. The percentage change in quantity demanded is infinite relative to the percentage change in price.

In this case, the demand curve is a horizontal straight line parallel to the ‘OX’ axis. So, the elasticity of demand is said to be infinite (E_d = ∞). Such a situation is found in a perfect competitive market.

Question 11.
Perfectly inelastic demand
Answer:
In this case, the change in price does not have any effect on the quantity demanded. The demand is non – responsive to a change in price.
Perfectly inelastic demand is also known as ‘zero’ elastic demand.
In this case the demand curve will be vertical on the ‘OY’ axis. Hence, the elas-ticity value is said to be zero. (E_d = ∞). For instance, salt has perfectly inelastic demand.

Question 12.
Price elasticity of demand
Answer:
Price elasticity of demand refers to the responsiveness of the quantity demanded of a good to a change in the price of that commodity, other things remaining constant. It is a measure of the responsiveness. In other words, price elasticity of demand is the ratio of the percentage change in quantity demanded of a good to the percentage change in its price.

Question 13.
Cross elasticity of demand
Answer:
Cross Elasticity of Demand refers to the change (increase or decrease) in the quantity demanded of a good in response to the change (increase or decrease) in the price of its related goods, assuming other factors remaining constant. Substitute goods like tea and coffee have positive cross elasticity of demand, where as complementary goods like automobiles and fuel consumption, has negative cross elasticity of demand.

Question 14.
Income elasticity of demand
Answer:
Income Elasticity of Demand represents the degree of responsiveness of demand for a commodity to a change (increase or decrease) in the income of the consumer, assuming other things remain constant. Income Elasticity of Demand will be positive for superior goods like LED TVs, ACs and negative for inferior goods like ragi, bajra and broken rice etc.

Question 15.
‘Arc’ method
Answer:
The term ‘Arc’ refers to a portion or segment of a demand curve. In this method, elasticity of demand is calculated in a segment of the demand curve between two points.
Hence, the ‘Arc Method’ is also known as the average method or mid-point method.

V. Write the answers briefly for the following questions. (4 Marks)

Question 1.
Mention any four factors that determine demand With examples.
Answer:
There are a number of factors that determine the demand for a good. The following are some of the important factors that determine demand.
1) Price of the Commodity (P_x): The demand for a commodity is ordinarily inversely related to its price. If the price of a commodity falls, its demand increases and vice versa, assuming other things remaining constant. Thus, the price of the commodity is an important determinant of its demand.
For example, if the price of a popular brand of coffee goes up, some consumers may switch to cheaper alternatives or reduce their consumption, leading to . lower demand.

2) Prices of Substitutes and Complementaries (P_r): Demand for a commodity is also influenced by the prices of its substitutes or complementaries. Tea and coffee are substitute goods.
For instance, an increase in the price of coffee leads to an increase in the de-mand for tea and vice versa. In the case of substitutes, there exists a positive relationship between price and demand.

Automobiles and fuel are complementary goods. If the price of fuel falls the demand for automobiles increases and vice versa. In the case of complemen- taries there exists a negative relationship between the price and the demand.

3) Tastes and Preferences (T): The demand for a commodity may change due to changes in tastes, preferences, and fashion. Tastes vary from person to person and tastes do not remain the same forever. For instance, an increase in the use of trousers reduced the demand for dhotis due to a change in fashion. Advertisements also influence demand for particular commodities.

4) Population: A change in the size of the population will affect the demand for certain goods. For instance, the larger the population, the greater will be the demand for certain goods like food grains, clothes, housing, etc.

Question 2.
Do you agree with the law of demand ? Explain your answer.
Answer:
Demand : In Economics, demand means a desire which is backed up by ability to buy and willingness to pay the price is called demand.

Law of Demand: It explains the relationship between price and quantity demanded of a commodity.
Price demand states that there is an inverse or negative relationship between price and quantity demanded of a commodity at a given point of time. Symbolically, D_x = f(P_x)
Where, D_x = Demand for commodity ‘X’, f = Functional relationship,
P_x = Price of good X

Assumptions of the Law of Demand:

1. No change in the income of the consumer.
2. No change in the prices of substitutes or complements.
3. No change in the tastes and preferences of the consumer
4. No new substitutes are discovered or invented.
5. No expectation of future price changes.

Demand Curve: The demand curve ‘DD’ represent various quantities demanded at various prices.
Thus, the demand curve ‘DD’ shows the inverse relationship between price and quantity demanded. In such a situation, the demand curve has a downward slope or negative slope from left to right.

Question 3.
Why does a demand curve have a negative slope or downward slope’trom left to right ?
Answer:
Law of Demand: According to Alfred Marshall, the law of demand states, that “The amount demanded increases with a fall in price and diminishes with a rise in price when other things remain the same”.

Thus, there is an inverse or negative relationship between price and quantity demanded of a commodity at a given point of time. Hence the demand curve has a downward slope or negative slope from left to right.
Reasons for the Downward (or) Negative Slope of Demand Curve: Generally, the demand curve possesses a negative slope. The following are the main reasons for the negative slope of a demand curve.

1) Old and new buyers: if the price of a good falls, the real income of the old buyers will increase. Consequently, the demand for the good may increase. In the same way, new buyers, who were unable to buy the good at a higher price, will be able to purchase it after a fall in its price. As a result, the demand curve slopes downward from left to right.

2) Multiple uses of a commodity: There are some commodities that have multiple uses such as milk, coal, and electricity. If the prices of these commodities fall, they may be demanded for other uses also. Thus, there will be a greater demand for these goods compared to those that are restricted to a particular use.

3) Law of Diminishing Marginal Utility: According to this law, if a consumer consumes more of a particular good, the utility that they get from additional units of that good will diminish. The price of a commodity that a consumer is ready to pay will not be more than the utility provides it. In other words, the consumer will prefer to pay a lower price for additional units of a good as the utility of additional units diminishes. As a result, the demand curve slopes downward from left to right.

4) Income effect: When the price of a commodity falls, the consumer’s real in-come (purchasing power) increases. The consumer can buy the same quantity of the commodity with less money or buy more of the same commodity with the money that becomes available for additional purchase. This leads to a rise in consumer’s real income (purchasing power), and thus demand for that com-modity (whose price has fallen) increases. This is called the “income effect”.

5) Substitution effect: When the price of a commodity falls, it becomes relatively cheaper than its substitutes. People will substitute cheaper goods for dearer goods. So, demand increases. This is called “substitution effect”. For example, when the price of tea falls, it becomes relatively cheaper than coffee, and people start substituting tea for coffee.

Question 4.
Distinguish between relatively elastic demand and relatively inelastic demand with numerical examples.
Answer:
1) Relatively Elastic Demand: This refers to a situation where a small percentage change in the price of a commodity is accompanied by a greater percentage change in its quantity demanded. Here, elasticity is said to be greater than unity (E_d > 1).

In this case the shape of demand curve is flatter, as shown in figure. For instance, the price of a commodity is Rs. 10 and the quantity demanded is 100 units. If the quantity demanded increases to 150 units, due to a fall in the price of the commodity to Rs. 8, then the value of elasticity of demand would be:
Here, ∆Q = 50 units, Q = 100 units
∆P = Rs. – 2, P = Rs. 10

E_P = \(\frac{\Delta Q}{\Delta P}\) × \(\frac{P}{Q}\) = \(\frac{50}{-2}\) × \(\frac{10}{100}\) = \(\frac{500}{-200}\) = -2.5 or 2.5 (The minus sign is ignored) E_d > 1.

2) Relatively Inelastic Demand : This is a situation where, the percentage change in the price of a commodity is accompanied by a smaller percentage change in the quantity demanded. Such elasticity is said to be relatively inelastic demand. Here, the elasticity value is said to be less than unity (E_d < 1). In this case the shape of demand curve is steeper, as shown in figure.

For instance, the price of a commodity is Rs. 10, and the quantity demanded is 100 units. If the price falls to Rs. 8 and as a result, the quantity demanded increases to 110 units, then the value of elasticity of demand would be :
Here, ∆Q = 10 units, Q =100 units, ∆P = Rs. -2, P = Rs. 10

E_P = \(\frac{\Delta Q}{\Delta P}\) × \(\frac{P}{Q}\) = \(\frac{10}{-2}\) × \(\frac{10}{100}\) = \(\frac{100}{-200}\) = -0.5 or 0.5
(The minus sign is ignored) E_d > 1.

Question 5.
Calculate the price elasticity of demand with the help of the point method.
Answer:
The point method of price elasticity of demand was introduced by Marshall and is also known as the ‘Geometrical Method.’ This method measures the proportionate change in quantity demanded as a result of a small proportionate change in price. In this method, elasticity of demand at any point is the ratio of the lower portion of the demand curve to the upper portion if it is a straight line or linear.

The Distance from the point to the X-axis The Distance from the point to the Y-axis
The above formula is used to measure elasticity at any point on the straight line demand curve.
In the below diagram AE is the linear demand curve, which is 4 cms, in length.
Then,
Elasticity at point A, E_d = \(\frac{AE}{A}\) = \(\frac{4}{0}\) = ∞ (Perfectly elastic demand)

Elasticity at point B, E_d = \(\frac{BE}{BA}\) = \(\frac{3}{1}\) = 3 (> 1) (Relatively elastic demand)

Elasticity at point C, E_d = \(\frac{CE}{CA}\) = \(\frac{2}{2}\) = 1 (Unitary elastic demand)

Elasticity at point D, E_d = \(\frac{DE}{DA}\) = \(\frac{1}{3}\) = 0.33 (< 1) (Relatively inelastic demand)

Elasticity at point E, E_d = \(\frac{E}{EA}\) = \(\frac{0}{4}\) = 0 (Perfectly inelastic demand)

Question 6.
What are the factors that determine the price elasticity of demand ?
Answer:
Price elasticity of demand refers to the responsiveness of the quantity demanded of a good to a change in the price of that commodity, other things remaining constant.

Determinants of Price Elasticity of Demand:
1. Nature of the Commodity: In the case of necessaries, the elasticity of demand will be inelastic. For example, rice, pulses, sugar, salt, matchboxes and medicines etc., though the prices of these necessities change, there will be little or no change in the quantity demanded. On the other hand, in the case of luxuries, the demand will be more elastic. For example, gold, diamonds and costly goods possess more elastic demand.

2. Availability of Substitutes: The availability of substitutes influences the demand for a commodity to a certain extent. In cases where substitutes are available, the elasticity of demand will be high. But in the case of non-avail-ability of substitutes, the elasticity of demand will be low.

3. Multiple uses of the Commodity: The more the possible uses a commodity has, the greater will be its price elasticity of demand and vice versa. For instance, milk has several uses. If its price falls, it can be used for a variety of purposes like preparation of curd, cream, ghee and sweets. Hence, its demand is elastic.
However, if its price rises, its use will be restricted primarily to feeding children and sick persons. So, the demand in this case is inelastic.

4. Period of Time: In the long run, demand tends to be more elastic. The longer the time period considered, the greater the possibility of substitution for a cheaper good. For example, if the price of petrol increases in the short run, it may not be possible to replace the petrol engines with diesel engines. However, in the long run, it may be possible to replace petrol engines because diesel is now relatively, cheaper. Hence, in the long run, demand will be more elastic and in the short run demand will be less elastic.

5. Possibility of Postponement of Purchases: The purchase of certain commodities such as ACs, Cars, Washing machines etc., can be postponed. Hence, their demand is elastic. In contrast, essential commodities like medicines, detergents, text-books, stationery etc., cannot be postponed. Hence, their demand is ordinarily inelastic.

6. Price Level: If the price of a good is too high or too low, the elasticity of demand for these goods will be inelastic. On the other hand, if the price is moderate, the elasticity of demand for these goods will be elastic.

7. Goods leading to Addiction: In the case of habit forming commodities like tobacco and alcohol, the demand for such goods will tend to be inelastic.
Consumers who are accustomed to using these goods will buy them even if the prices of these goods increase. In the case of non-habitual consumers, the demand for these goods is elastic.

8. Proportion of Income Spent: In the case of goods on which the proportion of income spent is small or negligible, their demand is inelastic. E.g.: Salt, matchboxes, stationery etc.

Question 7.
Explain any four points on the importance of price elasticity of demand.
Answer:
The following are the important uses of price elasticity of demand.
1. Price Determination and Discrimination: Monopolists and firms under im-perfect competition will set a higher price when the commodity has inelastic demand but will set a lower price when the commodity has elastic demand. If the demand for a product has different elasticities in different markets, the producer can set different prices in each market.

2. Useful to Joint Products: The elasticity of demand is useful in ptice fixation of joint goods like meat and fur, sugar and molasses etc. It is difficult to ascertain separate costs for these joint goods. In such cases, the producer will be guided by elasticity of demand to set the prices of joint goods. So, a higher price is set for a good with inelastic demand and a lower price is set for a good with elastic demand.

3. Useful to the Government in Declaring Public Utilities: Demand for certain essential services for the general public is generally inelastic. E.g.: elasticity Of transport etc. If such services are controlled by the private sector, private firms may fix high prices for them, as their demand is inelastic. The government takes over them and declares these services as public utilities. Elasticity enables the government to make policy decisions in such cases.

4. Useful in International Trade: Trade between two countries is possible only by taking into consideration the mutual elasticities of demand for each other’s products. Terms of Trade’ refers to the rate at which one unit of domestic commodity will exchange for a unit of foreign commodity. In calculating the terms of trade, both countries must take into account the mutual elasticities of demand for their products.

VI. Write an essay on the following questions. (8 Marks)

Question 1.
Distinguish between income demand and cross demand with the help of diagrams.
Answer:
A. Income demand : Income demand explains the relationship between a consumer’s income and various quantities of goods and services demanded at various levels of income, assuming that other factors remain constant. These factors include the price of the good, the price of related goods, tastes, preferences, etc., symbolically, the functional relationship between income and demand is shown below.
D_x = f(Y)
Where, D_x = Demand for good X, Y = Income of a consumer, f = Functional relationship.

This means the quantity demanded of good X is a function of the consumer’s income. The functional relationship between income and quantity demanded may be inverse or direct depending on the nature of the commodity.

Superior / Normal Goods:

• In the case of superior or normal goods, such as cereals, pulses, home appliances etc., demand increases when there is an increase in the income of consumers. The income demand for superior goods exhibits a positive relationship between income and demand.
  
• In Diagram, the OX-axis represents the demand for superior goods and the OY-axis represents the income of the consumer.
• YD represents the income demand curve, showing a positive slope.
• Whenever income increases from OY to OY, the demand for superior or normal goods increases from OQ to OQ, and vice versa.

Inferior Goods:

• In the case of inferior goods such as ragi, bajra and broken rice etc., demand decreases with an increase in the income of consumers. The income demand for inferior goods exhibits an inverse relationship between income and demand.
  
• In Diagram, the OX-axis represents the demand, and the OY-axis represents the income of the consumer.
• YD is the income demand curve for inferior goods, which has a negative slope.
• When the consumer’s income increases from OY to OY, the demand for the commodity decreases from OQ to OQ₁ and vice versa.

B. Cross Demand:
Cross Demand refers to the relationship between any two goods that are either complementary or substitutes for each other. When other factors remain constant, the functional relationship between the quantity demanded of a commodity and the price of another commodity is called cross demand.

Substitute Goods : Substitutes are goods that satisfy the same want. For ex-ample, tea and coffee, pepsi and coca-cola etc. There is an positive relationship between price and demand in case of Substitute goods. If the price of coffee decreases, while the price of tea remains constant, then the demand for tea decreases, especially if the existing price of tea is higher than the new price of coffee.

In such cases, consumers shift their demand from tea to coffee. Similarly, if the price of coffee increases, while the price of tea remains constant, the demand for tea increases. Hence, in the case of substitutes, the demand curve has a positive slope i.e., it slopes upward from left to right.

• In the Diagram, the OY-axis represents the price of coffee and the OX-axis represents the demand for tea.
• An increase in the price of coffee from OP to OP₂ leads to an increase in the demand for tea from OQ to OQ₂.
• Hence, in the case of substitute goods the demand curve slopes upward from left to right.

Complementary Goods : Complementary goods are those goods that satisfy the same want jointly. For instance, cars and fuel, shoes and socks, bread and butter, lock and key etc. There is an inverse relationship between price and demand in case of Complementary goods. The demand curve for complementaries slopes downward.
Example: If the price of fuel decreases, the demand for cars increases, with the prices of cars remaining constant.

• In Diagram, the price of fuel is shown on the OY-axis and the demand for cars is shown on the OX-axis.
• If the price of fuel decreases from OP to OP₂ the demand for cars may increase from OQ to OQ₂ and vice versa.
• Thus the cross demand curve for complementaries slopes downward.

Question 2.
Explain the three methods of Measuring Price Elasticity of Demand.
Answer:
The elasticity of demand can be measured mainly in three ways.
1. Total Outlay or Expenditure Method
2. Point Method
3. Arc Method

(1) Total Outlay or Expenditure method : This method was introduced by Alfred Marshall. In this method, price elasticity of demand can be measured based on the change in total outlay due to a change in the price of a commodity. Total outlay is calculated by multiplying the quantity demanded (Q) by the price of the commodity (P).
Total Outlay = Price × Quantity demanded

According to this method, the price elasticity of demand is expressed in three forms, they are elastic demand, unitary elastic and inelastic demand. This can be explained with the help of table.

(a) Elastic Demand (E_d > 1): When total expenditure increases with a fall in price and decreases with a rise in price, the demand is said to be elastic. For in-stance, as seen in table if the price of apples falls from Rs. 60 to Rs. 50, the total expenditure increases from Rs. 60 to Rs. 100. In contrast, if the price of apples rises from Rs. 50 to Rs. 60, the total expenditure decreases from Rs. 100 to Rs. 60. This situation is called elastic demand.

(b) Unitary Elastic Demand (E_d = 1): When total expenditure remains the same with a fall or rise in price, the price elasticity of demand is said to be unitary elastic. For example, as shown in table, if the price falls from Rs. 40 to Rs. 30, or rises from Rs. 30 to Rs. 40, the total expenditure remains the same at Rs. 120. This is known as unitary elastic demand.

(c) Inelastic Demand (E_d < 1): When total expenditure decreases with a fall in price and increases with a rise in price, the price elasticity of demand is said to be inelastic. For example, as shown in table if the price falls from Rs. 20 to Rs. 10, the total expenditure decreases from Rs. 100 to Rs. 60. Similarly, if the price rises from Rs. 10 to Rs. 20 the total expenditure increases from Rs. 60 to Rs. 100. This is termed inelastic demand.

Graphical Explanation:

• In adjacent diagram, the price is measured on the OY-axis and total expenditure is measured on the OX-axis.
• The total outlay Curve AD is shown in three parts i.e., A to B, B to C and C to D.
• A to B explains elastic demand, B to C explains unitary elastic demand and C to D explains inelastic demand.

(2) Point Method: The point method of price elasticity of demand was introduced by Marshall and is also known as the ‘Geometrical Method. This method is used for small changes in price. In this method, elasticity of demand at any point is the ratio of the lower portion of the demand curve to the upper portion if it is a straight line or linear.

In adjacent diagram, AE is the linear demand curve, which is 4 cms, in length.

Elasticity at point A, E_d = \(\frac{AE}{A}\) = \(\frac{4}{0}\) = ∞ (Perfectly elastic demand)

Elasticity at point B, E_d = \(\frac{BE}{BA}\) = \(\frac{3}{1}\) = 3 (> 1) (Relatively elastic demand)

Elasticity at point C, E_d = \(\frac{CE}{CA}\) = \(\frac{2}{2}\) = 1 (Unitary elastic demand)

Elasticity at point D, E_d = \(\frac{DE}{DA}\) = \(\frac{1}{3}\) = 0.33 (< 1) (Relatively inelastic demand)

Elasticity at point E, E_d = \(\frac{E}{EA}\) = \(\frac{0}{4}\) = 0 (Perfectly inelastic demand)

(3) Arc Method : The term ‘Arc’ refers to a portion or segment of a demand curve. In this method, mid-points between the old and new prices and the quantities demanded are used.

This method studies a segment of the demand curve between two points.
Hence, the ‘Arc Method’ is also known as the average method or mid-point method.
Diagram shows that the ‘arc’ exists between points A and B on the demand curve ‘DD’. The formula given below is used to measure arc price elasticity of demand.

Question 3.
Explain the concepts of income elasticity and cross elasticity of demand.
Answer:
Income Elasticity of Demand: Income Elasticity of Demand represents the degree of responsiveness of demand for a commodity to a change (increase or decrease) in the income of the consumer, assuming other things remain constant. Income Elasticity of Demand will be positive for superior goods like LED TVs, ACs and negative for inferior goods like ragi, bajra and broken rice etc.

Where Q = Quantity, Y =Income, ∆Q Change in demand, ∆Y Change in income.

The concept ofincome elasticity is useful to manufacturers of various industrial products. They invest more in industries that produce goods which have more elastic demand. If national income increases, people’s per capita income also increases, leading to a rise in demand for certain durable goods.

Cross Elasticity of Demand:
Cross Elasticity of Demand refers to the change (increase or decrease) in the quantity demanded of a good in response to the change (increase or decrease) in the price of its related goods, assuming other factors remaining constant. Substitute goods like tea and coffee have positive cross elasticity of demand, where as complementary goods like automobiles and fuel consumption, has negative cross elasticity of demand.

Where, Q_x = Original quantity demanded of good X, P_y = Original price of good Y, ∆Q_x = Change in quantity demanded of good X, ∆P_y = Change in price of good Y.