## Wednesday, June 1, 2016

### Elasticity of Demand

Managerial point of view, it is very important to know the factors that can change the level of demand. It is addressed by the demand sensitivity. The study of demand sensitivity is the analysis of the sensitivity or responsiveness of demand for a product to the change in factors or parameters that constitute the underlying demand function. Price of product, price of raw materials used to produce the product, expectations of the price, consumer income, their preferences, their taste, etc. are the factors that can have an impact on the demand level. It is important for managers to be aware of the effects of altering these parameters when they are making decisions. For instance, a business recession comes into the picture. It, in turn, leads to reduce the consumer income. Then, a manager must know the effects of changes in the consumer income on demand. If, for example consumer income has reduced, the management can take the corrective action in advance such as the necessary cutting down of price. The price cut will offset a decline in sales caused by the fall in consumer income. Because of this action, the business wouldn’t be hampered and could be lifted up. These all would be possible through the use of the demand elasticity.

Isn’t it amazing that we can trap the sensitivity of demand in number terms? Elasticity of demand measures the responsiveness of the demand to changes in one of these parameters, keeping constant the other factors of the demand function. In demand function, demand is considered as a dependent variable and other parameters that influence the demand level are considered as the independent variables.

Elasticity of demand is defined as the percentage change in the demand; a dependent variable, resulting from a 1% change in the value of an independent variable; any one factor that has impact on the demand level. Elasticity of demand can be calculated using formula given below:

Here, one point should be noted that the denominator of the above mentioned formula should consider only one independent variable at a time. It will give the clear picture about how the demand responses to this particular independent variable.

Let’s clarify this concept using example. Consider the independent variable as price of a product. Now, let’s see how the price of a product has influenced its demand. When we take price (P) as an independent variable and demand (D) as a dependent variable, then the elasticity of demand is known as the price elasticity of demand. It is determined using formula, given below:

For example, assume two situation. One is when the cinema ticket price is \$5, the demand for a ticket is 20,000. Other one is when the cinema ticket price is \$6, the demand for a ticket is 10,000. Based on this information, let’s find how sensitive is the demand for a cinema ticket to its price.

So, a 1% increase in price from \$5 led the demand to reduce by 2.5%. Here negative sign reflects that the two parameters; price and demand move in the opposite direction. Demand is inversely proportional to price. This means, if price increases, the demand for a product decreases. Similarly, if price decreases, the demand for a product increases.

Price elasticity concept provides a useful measure of the effect of a price change on revenues. The Price elasticity of demand is specified in any one of the three range.

·         1: It means the absolute value (regardless of positive or negative value) of elasticity is more than one. It is known as elastic demand. It is a situation where a price change results a more than proportionate change in demand. In this case, total revenue will be lowered by a price increase and will be raised by a price decrease.

·         |2: It means the absolute value (regardless of positive or negative value) of elasticity is less than one. It is known as inelastic demand. It is a situation where a price change results a less than proportionate change in demand. In this case, total revenue will be lowered by a price decrease and will be raised by a price increase.

·          3: It means the absolute value (regardless of positive or negative value) of elasticity is exactly one. It is known as unitary elasticity. It is a situation where the effect of a price change exactly offset the change in demand. In this case, total revenue remain the same, regardless of price change.This can also be be done by custom writing professionals.

Elasticity of demand provides the basis to managers to decide on the level of current and future demand. As we see it is a very useful measure. Through elasticity of demand, one can get the clear picture of the demand scenario. At the same time, it provides the clear picture of the situational impact on total revenue as explained above.In Case a student finds all this too difficult then there are always assignment help websites to help the student.