BBA/BCCA-1st Year(PBM): Indian Heritage in Production & Consumption

(sources: Thakur Publications)

BBA-I & BCCA-II_BusinessEconomics_DemandForecasting

DEMAND FORECASTING

Introduction:

Today business enterprises are working under the conditions of uncertainties. Uncertainties can be minimized through planning and forecasting. The success of a business firm depends upon its ability to forecast future events.

Meaning of Demand Forecasting:

Future is uncertain. There is great deal of uncertainty with regard to demand. Since the demand is uncertain, production, cost, revenue, profit etc. are also uncertain. Through forecasting it is possible to minimize the uncertainties.

Forecasting simply refers to estimating or anticipating future events. It is an attempt to foresee the future by examining the past. Thus demand forecasting means estimating or anticipating future demand on the basis of past data.

Objectives of Demand Forecasting:

A. Short Term Objectives

1. To help in preparing suitable sales and production policies.

2. To help in ensuring a regular supply of raw materials.

3. To reduce the cost of purchase and avoid unnecessary purchase.

4. To ensure best utilization of machines.

5. To make arrangements for skilled and unskilled workers so that suitable labour

    force may be maintained.

6. To help in the determination of a suitable price policy.

7. To determine financial requirements.

8. To determine separate sales targets for all the sales territories.

9. To eliminate the problem of under or over production.

B. Long term Objectives

1. To plan long term production.

2. To plan plant capacity.

3. To estimate the requirements of workers for long period and make arrangements.

4. To determine an appropriate dividend policy.

5. To help the proper capital budgeting.

6. To plan long term financial requirements.

7. To forecast the future problems of material supplies and energy crisis.

Factors Affecting Demand Forecasting:

For making a good forecast, it is essential to consider the various factors governing demand forecasting. These factors are summarized as follows.

1. Prevailing business conditions: While preparing demand forecast it becomes necessary to study the general economic conditions very carefully. These include the price level changes, change in national income, per-capita income, consumption pattern, savings and investment habits, employment etc.

2. Conditions within the industry: Every business enterprise is only a unit of a particular industry. Sales of that business enterprise are only a part of the total sales of that industry. Therefore, while preparing demand forecasts for a particular business enterprise, it becomes necessary to study the changes in the demand of the whole industry, number of units within the industry, design and quality of product, price policy, competition within the industry etc.

3. Conditions within the firm: Internal factors of the firm also affect the demand forecast. These factors include plant capacity of the firm, quality of the product, price of the product, advertising and distribution policies, production policies, financial policies etc.

4. Factors affecting export trade: If a firm is engaged in export trade also it should consider the factors affecting the export trade. These factors include import and export control, terms and conditions of export, exim policy, export conditions, export finance etc.

5. Market behavior : While preparing demand forecast, it is required to consider the market behavior which brings about changes in demand.

6. Sociological conditions: Sociological factors have their own impact on demand forecast of the company. These conditions relate to size of population, density, change in age groups, size of family, family life cycle, level of education, family income, social awareness etc.

7. Psychological conditions: While estimating the demand for the product, it becomes necessary to take into consideration such factors as changes in consumer tastes, habits, fashions, likes and dislikes, attitudes, perception, life styles, cultural and religious bents etc.

8. Competitive conditions: The competitive conditions within the industry may change. Competitors may enter into market or go out of market. A demand forecast prepared without considering the activities of competitors may not be correct.

Process of Demand Forecasting/ Steps in Demand Forecasting:

Demand forecasting involves the following steps:

1. Determine the purpose for which forecasts are used.

2. Subdivide the demand forecasting programme into small I parts on the basis of

    product or sales territories or markets.

3. Determine the factors affecting the sale of each product and their relative

    importance.

4. Select the forecasting methods.

5. Study the activities of competitors.

6. Prepare preliminary sales estimates after, collecting necessary data.

7. Analyse advertisement policies, sales promotion plans, personal sales

    arrangements etc. and ascertain how far these programmes have been successful

    in promoting the sales.

8. Evaluate the demand forecasts monthly, quarterly, half yearly or yearly and

    necessary adjustments should be done.

9. Prepare the final demand forecast on the basis of preliminary forecasts and the

    results of evaluation.

METHODS OF DEMAND FORECASTING :

There are several methods to predict the future demand. All methods can be broadly classified into two. (A) Survey methods, (B) Statistical methods.

(A) Survey methods

Under this method surveys are conducted to collect information about the future purchase plans of potential consumers. Survey methods help in obtaining information about the desires, likes and dislikes of consumers through collecting the opinion of experts or by interviewing the consumers. Survey methods are used for short term forecasting. Important survey methods are (a) consumers interview method, (b) collective opinion or sales force opinion methodic) experts opinion method, (d) consumers clinic and (f) end use method.

(a) Consumers' interview method (Consumers survey): Under this method, consumers are interviewed directly and asked the quantity they would like to buy. After collecting the data, the total demand for the product is calculated. This is done by adding up all individual demands. Under the consumer interview method, either all consumers or selected few are interviewed. When all the consumers are interviewed, the method is known as complete enumeration method. When only a selected group of consumers are interviewed, it is known as sample survey method.

Advantages

1. It is a simple method because it is not based on past record.

2. It suitable for industrial products.

3. The results are likely to be more accurate.

4. This method can be used for forecasting the demand of a new product.

Disadvantages

1. It is expensive and time consuming.

2. Consumers may not give their secrets or buying plans.

3. This method is not suitable for long term forecasting.

4. It is not suitable when the number of consumer is large.

(b)Collective opinion method: Under this method the salesmen estimate the expected sales in their respective territories on the basis of previous experience. Then demand is estimated after combining the individual forecasts (sales estimates) of the salesmen. This method is also known as sales force opinion method.

Advantages

This method is simple.

1. It is based on the first hand knowledge of Salesmen.

2. This method is particularly useful for estimating demand of new products.

3. It utilizes the specialized knowledge of salesmen who are in close touch with the

   prevailing market conditions.

Disadvantages

1. The forecasts may not be reliable if the salespeople are not trained.

2. It is not suitable for long period estimation.

3. It is not flexible.

4. Salesmen may give lower estimates that make possible easy achievement of sales

quotas fixed for each salesman.

(c)Experts' opinion method: This method was originally developed at Rand Corporation in 1950 by Olaf Helmer Dalkey and Gordon. Under this method, demand is estimated on the basis of opinions of experts and distributors other than salesmen and ordinary consumers. This method is also known as Delphi method. Delphi is the ancient Greek temple where people come and prey for information about their future.

Advantages

1. Forecast can be made quickly and economically

2. This is a reliable method because estimates are made on the basis of knowledge

and experience of sales experts.

3. The firm need not spare its time on preparing estimates of demand.

4. This method is suitable for new products.

Disadvantages

1. This method is expensive.

2. This method sometimes lacks reliability

(d)Consumer clinics: In this method some selected buyers are given certain amounts of money and asked to buy the products. Then the prices are changed and the consumers are asked to make fresh purchases with the given money. In this way the consumers" responses to price changes are observed. Thus the behavior of the consumers is studied.

On this basis demand is estimated. This method is an improvement over consumer’s

interview method.

Merits

1. It provides an opportunity to study the behavior of consumers directly.

2. It provides reliable and realistic picture about future demand.

3. It gives useful information to aid in the decision making process.

Demerits

1. It is a time consuming method.

2. Selecting the participants is very difficult.

3. It is expensive.

4. Consumers may take it as a game. They may not reveal their preferences.

(e) End use method: This method is based on the fact that a product generally has different uses. In the end use method, first a list of end users (final consumers, individual industries, exporters etc.) is prepared. Then the future demand for the product is found either directly from the end users or indirectly by estimating their future growth. Then the demand of all end users of the product is added to get the total demand for the product.

Statistical Methods

Statistical methods use the past data as a guide for knowing the level of future demand. Statistical methods are generally used for long run forecasting. These methods are used for established products. Statistical methods include: (i) Trend projection method, (ii) Regression and Correlation, (iii) Extrapolation method, (iv) Simultaneous equation method, and (v) Barometric method.

(i)Trend projection method: Future sales are based on the past sales, because future is the grand-child of the past and child of the present. Under the trend projection method demand is estimated on the basis of analysis of past data. This method makes use of time series (data over a period of time). We try to ascertain the trend in the time series. The trend in the time series can be estimated by using any one of the following four methods:

(a) Least-square method, (b) Free-hand method, (c) Moving average method and (d)

semi-average method.

(ii) Regression and Correlation: These methods combine economic theory and statistical technique of estimation. Under these methods the relationship between the sales (dependent variable) and other variables (independent variables such as price of related goods, income, advertisement etc.) is ascertained. Such relationship established on the basis of past data may be used to analyse the future trend. The regression and correlation analysis is also called the econometric model building.

(iii) Extrapolation: Under this statistical method, the future demand can be extrapolated by applying Binomial expansion method. This method is used on the assumption that the rate of charge in demand in the past has been uniform.

(iv) Simultaneous equation method.-This involves the development of a complete econometric model which can explain the behavior of all the variables which the company can control. This method is not very popular.

(v) Barometric technique: This is an improvement over the trend projection method. According to this technique the events of the present can be used to predict the directions of change m the future. Here certain economic and statistical indicators from the selected time series are used to predict variables. Personal income, non-agricultural placements, gross national income, prices of industrial materials, wholesale commodity prices, industrial production, bank deposits etc. are some of the most commonly used indicators.

Advantages of Statistical Methods:

1 The method of estimation is scientific

2 Estimation is based on the theoretical relationship between sales (dependent

variable) and price, advertising, income etc. (independent variables)

3 These are less expensive.

4 Results are relatively more reliable.

Disadvantages of Statistical Methods

1 These methods involve complicated calculations.

2 These do not rely much on personal skill and experience.

3 These methods require considerable technical skill and experience in order to be

effective.

Methods of Demand Forecasting for New Products:

Demand forecasting of new product is more difficult than forecasting for existing. The reason is that the product is not available. Hence, no historical data are available. In these conditions the forecasting is to be done by taking into consideration the inclination and wishes of the customers to purchase. For this a research is to be conducted. But there is one problem that it is difficult for a customer to say anything without seeing and using the product before. Thus it is very difficult to forecast the demand for new products. Any way Prof. Joel Dean has suggested the following methods for forecasting demand of new products:

1. Evolutionary approach: This method is based on the assumption that the new product is the improvement and evolution of the old product. The demand is forecasted on the basis of the demand of the old product. For example, the demand for black and white TV should be taken in to consideration while forecasting the demand for colour TV sets because the latter is an improvement of the former.

2. Substitute approach: Here the new product is treated as a substitute of an existing product, e.g. polythene bags for cloth bags. Thus the demand for a new product is analysed as a substitute for some existing goods or service.

3. Growth curve approach: Under this method the growth rate of demand of a new product is estimated on the basis of the growth rate of demand of an existing product. Suppose Pears soap is in use and a new cosmetic is to be introduced in the market. In this case the average sale of Pears soap will give an idea as to how the new cosmetic will be accepted by the consumers.

4. Opinion poll approach: Under this method the demand for a new product is estimated on the basis of information collected from the direct interviews (survey) with consumers.

5. Sales Experience approach: Under this method, the new product is offered for sale in a sample market, i.e. by direct mail or through multiple shop or departmental shop. From this the total demand is estimated for the whole market.

6. Vicarious approach: This method consists of surveying consumers' reactions through the specialized dealers who are in touch with consumers. The dealers are able to know as to how the customers will accept the new product. On the basis of their reports demand can be estimated. The above methods are not mutually exclusive. It is desirable to use a combination of two or more methods in order to get better results.

BBA-I & BCCA-II;BusinessEconomics_ElasticityofDemand

Elasticity of Demand:

Introduction:

Elasticity is a common concept that economists, Business people and others rely upon for the measurement between two variables say for example the ratio of percentage change in quantity demanded to percentage change in some other factor like Price or Income.

The concept of price-elasticity of demand was first of all introduced in economics  by Dr. Marshall. In simple words, price elasticity of demand is the ratio of percentage change in quantity demanded to the percentage change in price. In other words, price elasticity of demand is a measure of the relative change in quantity purchased of a good in response to a relative change in its price. It is, thus a rate at which the demand changes to the given change in prices. So, it means the rate or the degree of response in demand to the change in price. Thus, the co-efficient of price-elasticity of demand can be expressed as under:

Definitions of Price Elasticity of Demand:

The concept of price elasticity of demand has been defined by different economists as

under :

According to Alfred Marshall: "Elasticity of demand may be defined as the percentage change in quantity demanded to the percentage change in price."

According to A.K. Cairncross : "The elasticity of demand for a commodity is the rate at which quantity bought changes as the price changes."

According to J.M. Keynes : "The elasticity of demand is a measure of the relative change in quantity to a relative change in price."

According to Kenneth Boulding : "Elasticity of demand measures the responsiveness of demand to changes in price."

DEGREES OF PRICE ELASTICITY:

Different commodities have different price elasticities. Some commodities have more elastic demand while others have relative elastic demand. Basically, the price elasticity of demand ranges from zero to infinity. It can be equal to zero, less than one, greater than one and equal to unity.

According to Dr. Marshall : "The elasticity or reponsiveness of demand in a market is great or small according as the amount demanded increases much or little for a given fall in price and diminishes much or little for a given rise in price."

However, some particular values of elasticity of demand have been explained as under ;

1. Perfectly Elastic Demand:

Perfectly elastic demand is said to happen when a little change in price leads to an infinite change in quantity demanded. A small rise in price on the part of the seller reduces the demand to zero. In such a case the shape of the demand curve will be horizontal straight line as shown in figure:

The figure shows that at the ruling price OP, the demand is infinite. A slight rise in price will contract the demand to zero. A slight fall in price will attract more consumers but the elasticity of demand will remain infinite. But in real world, the cases of perfectly elastic demand are exceedingly rare and are not of any practical interest.

1. Perfectly inelastic Demand:

Perfectly inelastic demand is opposite to perfectly elastic demand. Under the perfectly inelastic demand, irrespective of any rise or fall in price of a commodity, the quantity demanded remains the same. The elasticity of demand in this case will be equal to zero.In diagram, DD shows the perfectly inelastic demand. At price OP, the quantity demanded is OQ. Now, the price falls to OP, from OP1, demand remains the same. Similarly, if the price rises to OP2 the demand still remains the same. But just as we do not see the example of perfectly elastic demand in the real world, in the same fashion it is diffcult to come across the cases of perfectly inelastic demand because even the demand for bare essentials of life does show some degree of responsiveness to change in price.

1. Unitary Elastic Demand. The demand is said to be unitary elastic when a given proportionate change in the price level brings about an equal proportionate change in quantity demanded, The numerical value of unitary elastic demand is exactly one i.e., ed = 1. Marshall calls it unit elastic.
   
   
   In figure, DD demand curve represents unitary elastic demand. This demand curve is called rectangular hyperbola. When price is OP, the quantity demanded is OQ1.
   
   
   Now price falls to OP1, the quantity demanded increases to OQ1. The shaded area in the fig. equal in terms of price and quantity demanded denotes that in all cases price elasticity of demand is equal to one.

4. Relatively Elastic Demand:
Relatively elastic demand refers to a situation in which a small change in price leads to a big change in quantity demanded. In such a case elasticity of demand is said to  be more than one. This has been shown in figure.
In fig, DD is the demand curve which indicates that when price is OP the quantity demanded is OQ1, Now the price falls from OP to OP1, the quantity demanded increases from OQ1 to OQ2 i.e. quantity demanded changes more than the change in price.

1. Relatively Inelastic Demand.

Under the relatively inelastic demand a given percentage change in price produces a relatively less percentage change in quantity demanded. In such a case elasticity of demand is said to be less than one as shown in figure.

All the five degrees of elasticity of demand have been shown in figure. On OX axis, quantity demanded and on OY axis price is given. It shows:

1.  AB---Perfectly Inelastic Demand

2. CD — Perfectly Elastic Demand

3. EQ — Less Than Unitary Elastic Demand

4. EF — Greater Than Unitary Elastic Demand

5. MN — Unitary Elastic Demand

FACTORS DETERMINING PRICE ELASTICITY OF DEMAND:

The factors that determine elasticity of demand are numberless. But the most important among them are the nature, uses and prices of related goods and the level of income. They are stated below:

I. Nature of the commodity: Generally, all commodities can be dividend into three

categories i.e.

(i) Necessaries of Life. For necessaries of life the demand is inelastic because people buy the required amount of goods whatever their price. For example, necessaries such as rice, salt, cloth are purchased whether they are dear or cheap.

(ii) Conventional Necessaries. The demand for conventional necessaries is less elastic or inelastic. People are accustomed to the use of goods like intoxicants which they purchase at any price. For example, drunkards consider opium and wine almost as a necessity as food and water. Therefore, they buy the same amount even when their prices are higher and highest.

(iii) Luxury Commodities. The demand for luxury is usually elastic as people buy more of them at a lower price and less at a higher price. For example, the demand of luxuries like silk, perfumes and ornaments increases at a lower price and diminishes at a higher price. Here, we must keep in mind that luxury is a relative term, which varies from person to person, place to place and from time to time. For example, what is a luxury to a poor man is a necessity to the rich. The luxury of the past may become a necessity of today. Similarly a commodity which is a necessity to one class may be a luxury to another. Hence, the elasticity of demand in such cases should have to be carefully expressed.
2. Substitutes. Demand is elastic for those goods which have substitutes and inelastic for those goods which have no substitutes. The availability of substitutes, thus, determines the elasticity of demand. For instance, tea and coffee are substitutes. The change in the price of tea affects the demand for coffee. Hence, the demand for coffee and tea is elastic.

3. Number of Uses. Elasticity of demand for any commodity depends on its number of uses. Demand is elastic; if a commodity has more uses and inelastic if it has only one use. As coal has multiple uses, if its price falls it will be demanded more for cooking, heating, industrial purposes etc. But if its price rises, minimum will be demanded for every

purpose.

4. Postponement. Demand is more elastic for goods the use of which can be postponed.

 silk is, therefore, elastic. Demand is inelastic for those goods the use of which is urgent and, therefore, cannot be postponed. The use of medicines cannot be put off. Hence, the demand for medicines is inelastic.

5. Raw Materials and Finished Goods. The demand for raw materials is inelastic but the demand for finished goods is elastic. For instance, raw cotton has inelastic demand but cloth has elastic demand. In the same way, petrol has inelastic demand but car itself has only elastic demand.

6. Price Level. The demand is elastic for moderate prices but inelastic for lower and higher prices. The rich and the poor do not bother about the prices of the goods that they buy. For example, rich buy Benaras silk and diamonds etc. at any price. But the poor buy coarse rice, cloth etc. whatever their prices are.

7. Income Level. The demand is inelastic for higher and lower income groups and elastic for middle income groups. The rich people with their higher income do not bother about the price. They may continue to buy the same amount whatever the price. The poor people with lower incomes buy always only the minimum requirements and, therefore, they are induced neither to buy more at a lower price nor less at a higher price. The middle income group is sensitive to the change in price. Thus, they buy more at a lower price and less at higher price.

8. Habits. If consumers are habituated of some commodities, the demand for such commodities will be usually inelastic. It is because that the consumer will use them even

their prices go up. For example, a smoker does not smoke less when the price of cigarette goes up.

9. Nature of Expenditure. The elasticity of demand for a commodity also depends as to how much part of the income is spent on that particular commodity. The demand for such commodities where a small part of income is spent is generally highly inelastic i.e. newspaper, boot-polish etc. On the other hand, the demand of such commodities where a significant part of income is spent, elasticity of demand is very elastic.

10. Distribution of Income. If the income is uniformly distributed in the society, a small change in price will affect the demand of the whole society and the demand will be elastic. In case of unequal distribution of income and wealth, a change in price will hardly influence the poor section of the society and the demand will be relatively inelastic.

11. Influence of Diminishing Marginal Utility. We know that utility falls when we consume more and more units but not in a uniform way. In case utility falls rapidly, it means that the consumer has no other near substitutes. As a result, demand is inelastic. Conversely, if the utility falls slowly, demand for such commodity would be elastic and raises much for a fall in price.

MEASUREMENT OF PRICE ELASTICITY OF DEMAND

There are five methods to measure the price elasticity of demand.

1. Total Expenditure Method.

2. Proportionate Method.

3. Point Elasticity of Demand.

4. Arc Elasticity of Demand.

5. Revenue Method.

Total Expenditure Method

Dr. Marshall has evolved the total expenditure method to measure the price elasticity of demand. According to this method, elasticity of demand can be measured by considering the change in price and the subsequent change in the total quantity of goods purchased and the total amount of money spend on it.

Total Outlay = Price x Quantity Demanded.

There are three possibilities:

(i) If with a fall in price (demand increases) the total expenditure increases or with a rise

in price (demand falls) the total expenditure falls, in that case the elasticity of demand is

greater than one i.e. (Ed >1.)

(ii) If with a rise or fall in the price (demand falls or rises respectively), the total

expenditure remains the same, the demand will be unitary elastic i.e. (Ed = 1).

(iii) with a fall in price (Demand rises), the total expenditure also falls, and with a rise in

price (Demand falls) the total expenditure also rises, the demand is said to be less elastic

or elasticity of demand is less than one i.e. (Ed <1).

Table Representation: The method of total expenditure has been explained with the help

of Table:

1. More Elastic Demand. When price is Rs. 10 the quantity demanded is 1 unit and total expenditure is 10. Now price falls from Rs. 10 to Rs. 6, the quantity demanded increases from 1 to 5 units and correspondingly the total expenditure increases from Rs. 10 to Rs. 30. Thus it is clear that with the fall in price, the total expenditure increases and viceversa.

So elasticity of demand is greater than one or Ed > 1.

2.Unitary Elastic Demand. If price is Rs. 6, demand is 5 units so the total outlay is Rs. 30. Now price falls to Rs. 5, the demand increases to 6 units but the total expenditure remains the same i.e., Rs. 30. Thus it is clear that with the rise or fall in price, the total expenditure remains the same. The elasticity of demand in this case is equal to one or Ed = 1.

3.Less Elastic Demand. If price is Rs. 5, demand is 6 and total outlay is Rs. 30. Now price falls from Rs. 5 to Re. 1. The demand increases from 6 units to 10 units and hence the total expenditure falls from Rs. 30 to Rs. 10. Thus it is clear that with the fall in price, the total expenditure also falls and vice-versa. In this case, the elasticity of demand is less.

Diagrammatic Representation:

Measurement of price elasticity through total expenditure method can be shown with the help of fig.In the figure total expenditure has been shown on X-axis and price on Y-axis.

Line TT' is the total expenditure line. When price of the commodity falls from OP to OP1 total expenditure increases from OM1 to OM2. The elasticity of demand is greater than one as is shown in TB portion of the figure. Now, suppose that the price of the commodity decreases from OP1 to OP3 the total expenditure falls from OM2 to OM. This is shown in T'C part of the figure which represents the less than unity elasticity of demand. In the same way, BC part of the figure represents the unit elasticity of demand. Thus it is clear that the changes in total expenditure due to changes in price also affect the elasticity of demand.

Proportionate Method

This method is also associated with the name of Dr. Marshall. According to this method, "price elasticity of demand is the ratio of percentage change in the amount demanded to the percentage change in price of the commodity." It is also known as the Percentage Method, Flux Method, Ratio Method, and Arithmetic Method.

Arc Elasticity of Demand:

According to Prof. Baumol: "Arc elasticity is a measure of the average responsiveness to price change exhibited by a demand curve over some finite stretch of the curve".

According to Watson: "Arc elasticity is the elasticity at the mid-point of an are of a demand curve."

According to Leftwitch : "When elasticity is computed between two separate points on a demand curve, the concept is called Are elasticity." This method of measuring elasticity of demand is also known as

Where

Q1 = Original quantity demanded

Q2 = New quantity demanded

P1 = Original price

P2 = New price

This can be shown with the help of a diagram

In figure quantity is measured on X-axis while price on Y- axis. DD is the

demand curve. Now if we want to measure the arc elasticity between A and B on the

demand curve DD, we will have to take the average of prices OPl and OP2 as well as of

quantities; Q1 and Q2.

Revenue Method

Mrs. Joan Robinson has given this method. She says that elasticity of demand can be measured with the help of average revenue and marginal revenue. Therefore, a sale proceeds that a firm obtains by selling its products is called its revenue. However, when total revenue is divided by the number of units sold, we get average revenue. On the contrary, when addition is made to the total revenue by the sale of one more unit of the commodity is called marginal revenue. Therefore, the formula to measure elasticity of demand can be written as,

where Ed represents elasticity of demand, A = average revenue and M = marginal

revenue. This method can be explained with the help of diagram.

In this diagram revenue has been shown on OY-axis while quantity of goods on OXaxis.

AB is the average revenue or demand curve and AN is the marginal revenue curve.

At point P on demand curve, elasticity of demand is calculated with the formula,

In this way, if value of Ep is one it means that price elasticity of demand is unitary. Similarly, if it is more than one, price elasticity of demand is greater than one and if it is less than one, price elasticity of demand is less than unity.

INCOME ELASTICITY OF DEMAND

According to Stonier and Hague: "Income elasticity of demand shows the way in which a consumer's purchase of any good changes as a result of change in his income."

It shows the responsiveness of a consumer's purchase of a particular commodity to a change in his income. Income elasticity of demand means the ratio of percentage change in the quantity demanded to the percentage change in income. In brief income elasticity.

Degrees of Income Elasticity of Demand:

Positive income elasticity of Demand : Positive income elasticity of demand is said to occur when with the increase in the income of the consumer, his demand for goods and services also increases and vice-versa. Income elasticity of demand is positive in case of normal goods.

In fig, quantity of commodity T has been measured on X-axis and income of the consumer on Y-axis. DD is the positive income elasticity of demand curve. It slopes upward from left to right indicating that increase in income is accompanied by increase in demand of goods and services and vice-versa.

1.Income Elasticity is Unity. The change in demand is proportionate to the change in income. For example

2. Income Elasticity Greater than One. When the change in demand is more than

proportionate change in income, income elasticity of demand is greater than one or unity.

For example,

3. Income Elasticity Less than One. If change in demand is less than proportionate

change in income, income elasticity of demand is less than one or unity. For example.

(ii) Negative Income Elasticity of Demand: Negative income elasticity of demand is said to occur when increase in the income of the consumers is accompanied by fall in demand of goods and services and vice-versa. It is the case of giffen goods. In fig when income of the consumer is 01, demand for goods and services is OX. Now as the income I1 increases to I1 quantity demanded falls o to OX1. Again as the income increases to I2, quantity demanded falls to OX2. DD is the negative income elasticity of demand curve.

(iii) Zero Income Elasticity of Demand: Zero income elasticity of demand is said to exist when increase or decrease in income has no impact on the demand of goods and services.

In fig. initially when income is OI, quantity demanded is OD. Now, income increases to OI2 demand Remains constant i.e. OD. Even when income reduces to 01 , quantity demanded remains OD Generally, as income increases demand for goods increases. But in some cases, demand may not change to change in income or demand may diminish for an increase in income. The former case represents zero income elasticity. Income elasticity is zero if a change in income fails to produce any change in demand. Income elasticity is negative, if an increase in income leads to a reduction of demand. This happens only in the case of inferior goods. But in all other cases it is positive.

In short income elasticity is greater than one for luxuries but less than one for necessaries.

CROSS ELASTICITY OF DEMAND:

It is the ratio of proportionate change in the quantity demanded of Y to a given proportionate change in the price of the related commodity X. It is a measure of relative change in the quantity demanded of a commodity due to a change in the price of its substitute complement.

It can be expressed as:

Cross elasticity may be infinite or zero. It is infinite if the slightest change in the price of X causes a substantial change in the quantity demanded of Y. It is always the case with goods which have perfect substitutes for one another.

Cross elasticity is zero, if a change in the price of one commodity will not affect the quantity demanded of the other. In the case of goods which are not related to each other, cross elasticity of demand is zero.

Types of Cross Elasticity of Demand:

1.Positive : When goods are substitute of each other than cross elasticity of demanded is positive. In other words, when an increase in the price of Y leads to an increase in the demand of X. For instance with the increase in price of a tea, demand of coffee will increase. In fig Quantity has been measured on OX axis and price on OY axis. At price OP of Y commodity, demand of X – commodity is OM. Now as price Of Y commodity increase to OP1 demand of X-commodity increases to OM1. Thus, cross, elasticity of demand is positive.

2. Negative: In case of complementary goods, cross elasticity of demand is negative. A proportionate increase in price of one commodity leads to a proportionate fall in the demand, of .another commodity because both are demanded jointly In fig.quantity has been measured on OX-axis while price has been measured on OY-axis. When the price of commodity increases from OP to OP1 quantity demanded falls from OM to OM1 Thus, cross elasticity of demand is negative.

3. Zero: Cross elasticity of demand is zero when two goods are related to each other. For instance, increase in price of car does not affect the demand of cloth. Thus, cross elasticity of demand is zero. It has been shown in fig.

Therefore, it can be concluded that cross elasticity depends upon Sustainability is perfect, cross elasticity is infinite; if on the other hand, sustainability does not exist, cross elasticity is zero. In the case of complementary goods like jointly demanded goods cross elasticity is negative. A rise in the price of one commodity X will mean not only decrease in the quantity of X but also decrease in the quantity demanded of Y because both are demanded together.

Limitations of Cross Elasticity of Demand:

The cross elasticity of demand is a useful measure of price-demand relationships between

commodities. But this concept has following two limitations.

1. Negative Cross Elasticity does not always mean complementary.

2. Cross Elasticity of Demand is only a one-way Relationship.

IMPORTANCE OF ELASTICITY OF DEMAND:

The concept of elasticity of demand is of great importance in practical life. Its

main points are given as under:

1. Useful for Business: It enables the business in general and the monopolists in particular to fix the price. Studying the nature of demand the monopolist fixes higher prices for those goods which have inelastic demand and lower prices for goods which have elastic demand. In this way, this helps him to maximise his profit.

2. Fixation of Prices: It is very useful to fix the price of jointly supplied goods. In the case of joint products like paddy and straw, the cost of production of each is not known. The price of each is then fixed by its elastic and inelastic demand.

3. Helpful to Finance Minister: It helps the Finance Minister to levy tax on goods. After levying taxes more and more on goods which have inelastic demand, the Government collects more revenue from the people without causing them inconvenience. Moreover, it is also useful for the planning.

4. Fixation of Wages: It guides the producers to fix wages for labourers. They fix high or low wages according to the elastic or inelastic demand for the labour.

5. In the Sphere of International Trade: It is of greater significance in the sphere of international trade. It helps to calculate the terms of trade and the consequent gain from foreign trade. If the demand for home product is inelastic, the terms of trade will be profitable to the home country.

6. Paradox of Poverty. It explains the paradox of poverty in the midst of plenty. A bumper crop instead of bringing prosperity may result in disaster, if the demand for it is inelastic. This is specially so, if the products are perishable and not storable.

7. Significant for Government Economic Policies. The knowledge of elasticity of demand is very important for the government in such matters as controlling of business cycles, removing inflationary and deflationary gaps in the economy. Similarly, for price stabilization and the purchase and sale of stocks, information about elasticity of demand is most useful.

8. Determination of Price of Public Utilities. This concept is significant in the determination of the prices of public utility services. Economic welfare of the society largely depends upon the cheap availability.