Elasticity of Demand – Indian Economy UPSC Notes

Elasticity of demand measures how the quantity demanded of a good changes in response to a change in one of its determining factors, like price,income

Elasticity of Demand – UPSC Notes

Definition:

Elasticity of demand measures how the quantity demanded of a good changes in response to a change in one of its determining factors, such as price, income, or the price of related goods. It is a crucial concept in economics to understand consumer behavior and market dynamics.

Types of Elasticity of Demand

  1. Price Elasticity of Demand (PED):

    • Measures the responsiveness of the quantity demanded to a change in the price of the good.
    • Formula: PED=% Change in Quantity Demanded% Change in PricePED = \frac{\%\text{ Change in Quantity Demanded}}{\%\text{ Change in Price}}
    • Types:
      • Perfectly Elastic Demand (PED = ∞): Demand changes infinitely with a small price change.
      • Perfectly Inelastic Demand (PED = 0): Quantity demanded remains constant despite price changes.
      • Elastic Demand (PED > 1): A small price change leads to a larger change in demand.
      • Inelastic Demand (PED < 1): A price change results in a smaller change in demand.
      • Unitary Elastic Demand (PED = 1): Percentage change in demand equals the percentage change in price.
  2. Income Elasticity of Demand (YED):

    • Measures the responsiveness of demand to a change in consumer income.
    • Formula: YED=% Change in Quantity Demanded% Change in IncomeYED = \frac{\%\text{ Change in Quantity Demanded}}{\%\text{ Change in Income}}
    • Types:
      • Positive YED: Normal goods (e.g., cars, electronics).
      • Negative YED: Inferior goods (e.g., coarse grains, low-quality goods).
  3. Cross Elasticity of Demand (CED):

    • Measures how the quantity demanded of one good changes in response to the price change of another related good.
    • Formula: CED=% Change in Quantity Demanded of Good A% Change in Price of Good BCED = \frac{\%\text{ Change in Quantity Demanded of Good A}}{\%\text{ Change in Price of Good B}}
    • Types:
      • Positive CED: Substitute goods (e.g., tea and coffee).
      • Negative CED: Complementary goods (e.g., cars and fuel).
      • Zero CED: Unrelated goods (e.g., sugar and furniture).

Factors Affecting Elasticity of Demand

  1. Nature of Goods:

    • Necessities: Inelastic demand (e.g., rice, salt).
    • Luxuries: Elastic demand (e.g., smartphones, luxury cars).
  2. Availability of Substitutes:

    • More substitutes lead to higher elasticity.
  3. Proportion of Income Spent:

    • Higher proportion = higher elasticity (e.g., housing).
    • Lower proportion = lower elasticity (e.g., matchsticks).
  4. Time Period:

    • Short-term: Inelastic as adjustments take time.
    • Long-term: Elastic as consumers adapt.
  5. Addiction/Habitual Consumption:

    • Inelastic demand for goods like tobacco and alcohol.
  6. Durability of Goods:

    • Durable goods are more elastic as they can be reused.

Significance of Elasticity of Demand in Indian Economy

  1. Pricing Policies:

    • Helps businesses and the government set prices for goods and services.
    • Example: Petrol and diesel pricing consider inelastic demand.
  2. Taxation Policy:

    • Tax revenue depends on elasticity; inelastic goods like fuel and alcohol are heavily taxed.
  3. Subsidy Decisions:

    • Elasticity helps the government decide on subsidies for essentials like food grains.
  4. Agricultural Policies:

    • Inelastic demand for agricultural goods impacts Minimum Support Prices (MSP).
  5. Foreign Trade:

    • Elasticity influences trade policies. Example: Export demand for IT services is elastic.
  6. Welfare Economics:

    • Understanding elasticity aids in reducing the burden on the economically weaker sections through targeted subsidies.
  7. Consumer Behavior Analysis:

    • Insights into purchasing patterns help in framing market regulations.

Elasticity and India’s Economic Policies

  1. GST and Elastic Goods:

    • Essential goods have lower GST rates due to inelastic demand.
    • Luxury items have higher GST rates due to elastic demand.
  2. Price Controls:

    • Government sets price caps on essential goods like LPG cylinders, impacting consumer welfare.
  3. Petroleum Pricing:

    • The inelastic demand for petrol and diesel ensures stable government revenue despite price hikes.
  4. Subsidy Reform:

    • Subsidies on fertilizers, electricity, and LPG consider the elasticity of demand for rural and urban populations.
  5. Promotion of Exports:

    • Elasticity of demand in global markets shapes policies to boost export competitiveness.

Elasticity in UPSC Preparation

  • Mains GS Paper 3:
    Topics like market structure, pricing policies, and subsidies.
  • Prelims:
    Conceptual clarity for economic terms and government policies.
  • Essay Paper:
    Relevant in topics like “Role of Market in India’s Development” or “Balancing Welfare and Economic Growth.”

Post a Comment