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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: $$PED = \frac{\%\text{ Change in Quantity Demanded}}{\%\text{ Change in Price}}$$
   • 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: $$YED = \frac{\%\text{ Change in Quantity Demanded}}{\%\text{ Change in Income}}$$
   • 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: $$CED = \frac{\%\text{ Change in Quantity Demanded of Good A}}{\%\text{ Change in Price of Good B}}$$
   • 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.”

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