Unit I

Demand:
(Managerial Economics by R.Cauvery page no 44)
Demand in common parlance means the desire for an object. But in economics
demand is something more than this. According to Stonier and Hague, Demand
in economics means demand backed up by enough money to pay for the goods
demanded. This means that the demand becomes effective only if it is backed up
by purchasing power. In addition there must be willingness to buy a commodity.
Thus Demand in economics means desire backed up by willingness to buy a
commodity and the purchasing power to pay. Thus demand is always at a price for a
definite quantity at a specified time. Thus demand has three essentials price,
quantity demanded and time. Without these, demand has no significant in
economics.

Definition:
The Demand for anything at a given price is the amount of it which will be bought
per unit of time at that price
Benham.

Law of Demand:
(Managerial Economics by R.Cauvery page no 44)
Statement:
The amount demanded increases with a fall in price and diminishes with a rise in
price.
Marshall

Explanation:
Law of Demand shows the relation between price quantity demanded of a
commodity in the market. A rise in the price of a commodity is followed by a
reduction in demand and a fall in price is followed by an increase in demand, if
condition of demand remains constant.
The law of demand may be explained with the help of a demand schedule. Demand
schedule is a list of quantities of a commodity purchased by a consumer at different
prices.
Demand Schedule
Price of Apple Quantity
(In Rs) Demanded
10 1
8 2
6 3
4 4
2 5

When the price falls from Rs. 10 to 8, quantity demanded increase from one to two.
In the same way as price falls, quantity demanded increases. On the basis of the
demand schedule we can draw the demand curve.
 The demand curve DD shows the inverse relation between price and quantity
demanded of apple
Assumptions:
(Managerial Economics by R.Cauvery page no 47)
Law of demand is based on certain assumptions:
1. There is no change in consumers taste and preferences.
2. Income should remain constant.
3. Prices of other goods should not change.
4. There should be no substitute for the commodity.
5. The commodity should not confer any distinction.
6. The demand for the commodity should be continuous.
7. People should not expect any change in the price of the commodity.

Why demand curve slopes downwards? (Managerial

Economics by R.Cauvery page no 47)
Demand curve has a negative slope. i.e., it slopes downwards. There are many
causes for the downward sloping nature of the demand curve.
1. Demand curve slopes downward to the right because the law of demand is
based on the law of diminishing marginal utility. As the consumers buys more
and more of a commodity, the marginal utility of the additional unit falls.
Therefore, the consumer is willing to pay lower prices for additional units.
That is why the demand curve slopes downward.
2. The demand curve slopes downward because of the operation of the principle
of equi-marginal utility. The consumer will arrange their purchases in such a
way that marginal utility is equal in all purchases. Suppose if it is not equal,
they will alter their purchases till the marginal utility is equal. When the price
of one commodity falls, they will buy more thus reaching a new equilibrium,
at which marginal utilities are equal.
3. The law of demand operates on account of the commodities having different
uses. Some commodities have several uses. If the price of commodity is high,
its use will be restricted only for important uses. When price falls, it will be
used for less important uses. For e.g., when the price of tomato is high, it will
be used only for cooking purposes. When it is cheaper, it will be used for
preparing jam, pickle etc.
4. Different income levels of the consumers also is responsible for the downward
sloping nature of the demand curve. If the supply of the commodity is less, it
can be sold to the rich people at a higher price. If the supply is more it can be
sold to the poor people at a lower price.
5. The downward sloping nature of demand curve can be explained in terms of
income effect and substitution effect. When the price of the commodity falls,
 the real income of the consumer increases. For e.g., when the price of rice
falls the consumer after buying the usual quantity, will have some more
money with him. He will spend this money either to buy additional quantity of
rice or some other quantity. This increase in demand is due to income effect.
6. Psychologically people buy more of a commodity when its price falls. Hence
the demand curve slopes downward.

Exceptional demand Curve: (Managerial

Economics by R.Cauvery page no 48)
Sometimes the Demand curve slopes upward from left to right. In this case the
demand curve has a positive slope. When prices increases from OP to OP 1
quantity demanded also increases from OQ to OQ 1 and vise versa. The reasons
for exceptional demand curve are as follows

1. Giffen Paradox. (Fundamentals of Business Economics by

D.M.Mithani and G.K.Mithani page no 56)
In the case of certain inferior goods called Giffen goods, when the price falls, quite
often less quantity will be purchased than before because of the negative income
effect and peoples increasing preference for a superior commodity with a rise in
their real income. This was first explained by Giffen and therefore it is called as
Giffens paradox.
2. Veblen effect/Demonstration effect/Goods that has a status symbol.
Rich people buy certain goods because it gives social distinction or prestige. For
Example, diamonds are bought by the richer class for the prestige it posses. If the
price of diamonds falls, poor also will buy and hence they not give prestige.
Therefore, rich people may stop buying this commodity.
3. Ignorance.
Sometimes the quality of the commodity is judged by its price. Consumer thinks
that the product is superior if the price is high. As such they buy more at a higher
price.
4. Speculative Effect.
If the price of the commodity is increasing then the consumer will buy more of it
because of the fear that it will increase still further. Thus, an increase in price may
not be accompanied by a decrease in demand.
5. Fear of Shortage.
During times of emergency or war, people may expect shortage of a commodity. At
that time, they may buy more at a higher price to keep stocks for the future.
6. Necessaries.
In the case of necessaries like rice, vegetables etc. people buy more even at a
higher price.

Determinants of demand:
(Economics for Managers by ICFAI page no 19)
The demand for a product largely depends on its price. But price is not the only
factor that influences demand. The demand for a product also depends on other
factors, let us try to understand these factors in detail.
1. Income of the consumers.
Consumption is influenced by the income of a consumer. With every increase in the
income of a consumer, his consumption pattern changes i.e., the purchasing power
of the consumer increases.
2. Price of the substitute product.
A substitute product is one that provides the same level of satisfaction as the
product already being consumed by the consumer. Assume that two products A and
B are perfect substitutes for each other. If the price of a product A goes up, while B
remains constant, consumer will switch to product B.
3. Price of complimentary product.
Complimentary products are products that are consumed together. For example, car
and petrol or shoe and polish, etc. in this case, if the price of one product goes up
the demand for the other product decreases.
4. Changes in policy.
The demand of a particular product also depends upon government policies. For
example, if the government increases taxes on products, prices increase and hence
the demand decreases in short run. Change in government policies may also have a
negative impact on the demand for a particular product. The AP governments ban
on gutkha (Tobacco) had a negative impact on the demand for tobacco in
Andrapradesh. Now the tobacco industry in AP is facing over supply as a result of
lack of demand for tobacco products and hence the companies operating in this
industry have to search for newer markets in other states.
5. Population.
(Business Economics by V.G.Mankar page no 38)
If there is any change (increase or decrease) in the total population, sex-ratio or
occupational structure, the demand for a commodity will change. For example,
when children are born, the demand for milk, milk foods etc., will increase. Again ,
every year, there is an increase in the number of school-going children, college
students, etc., more quantities of school uniform, books, etc., are brought by
people, even though the price of these goods do not fall.
6. Advertisement Effect. (Economics for
managers by D.M.Mithani page no 74)
In modern times, the preferences of a consumer can be altered by advertisement
and sales propaganda, albeit to a certain extent only. In fact, demand for many
products like toothpaste, toilet soap, washing powder, processed foods, etc., is
partially caused by the advertisement effect in a modern mans life.

Types of Demand: (Modern

economic theory by K.K.Dewett page no 43)
The demand behavior of the buyer or consumer differs with different types of
demand. From managerial business economics point of view, thus, we may
distinguish the following important types of demand
1. Price Demand.
Price demand refers to the various quantities of a commodity or service that a
consumer would purchase at a given time in a market at various hypothetical
prices. It is assumed that other things, such as consumers income his tastes and
price of inter-related goods remain unchanged.
The demand of the individual consumer is called Individual demand and the total
demand of all the consumer combined for the commodity or service is called
Industry Demand.
2. Income Demand.
The income demand refers to the various quantities of goods and services which
would be purchased by the consumers at various levels of incomes. Here we
assume that the price of the commodity or service as well as the price of inter-
related goods and the tastes and desires of consumers do not change.
3. Cross Demand.
The cross demand means the quantities of a goods or service which will be
purchased with reference to change in price not of this good but of other inter-
related goods. These goods are either substitutes or complimentary goods. A
change in the price of tea, for instance, will affect the demand for coffee.

Demand Forecasting:
(Managerial Economics by R.Cauvery page no 83)
The information about the future is essential for both new firms and those planning
to expand the scale of their production. Most firms are confronted with the problem
of forecasting the demand for their product. Therefore it is indispensable for the firm
to have at least a rough estimate of the demand prospects as they have to acquire
inputs, both men and material, organize production, advertise the product and
organize sales channel s. these functions can hardly be performed satisfactorily in
an atmosphere of uncertainty regarding demand for the product.
In the modern competitive environment, an organization must have some idea
about the demand for its products. The high degree of business uncertainty makes
it difficult for an organization to predict future sales volumes of their products and
decide how a company can use its scare resources effectively. Demand forecasting
helps an organization to solve this problems to a large extend.
Demand forecasting refers to an estimate of future demand for the product. It is an
objective assessment of the future course of demand. In recent times, forecasting
plays an important role in business decision making. The survival and prosperity of
a business firm depends on its ability to meet the consumers needs efficiently and
adequately.

Steps involved in Forecasting: (Engineering Economics and

Financial Accounting by B.Senthil Arasu and
J.Praveen Paul. Page no 4.2)
The following are the necessary steps which will ensure a good forecast.
1. Identify and clearly state the objective of forecasting Short term or Long term,
market or industry as a whole etc.
2. Select appropriate method for forecasting. The selection of an appropriate
method for forecasting depends on the objective of forecasting. Different
objectives will use different tools.
3. Identify the variables affecting the demand for the product and express them in
appropriate form.
4. Getter the relevant data to represent the variables.
5. Determine the most probable relationship between the dependent variable and
independent variables through the use of statistical techniques.
6. Prepare the forecast and interpret the results. Interpretation of the analysis of
the data is usually done by the management.

Methods of Demand Forecasting: (Managerial

Economics by R.Cauvery page no 85)
Several methods are employed for forecasting demand. All these methods can be
grouped under Survey Methods and Statistical Methods.
(A) Survey Method:
Under this method, information about the desires of the consumers and opinion of
experts are collected by interviewing them. Survey method can be divided into four
types viz.,
1. Opinion Survey Method:
This method is also known as Sales Force Composition method or Collective opinion
method. Under its method, the company asks its salesmen to submit estimates of
future sales in their respective territories. These estimates are consolidated,
reviewed and adjusted by the top executives. In case of wide difference, an average
is struck to make the forecast realistic.
Advantages.
1. This method is simple and straight forward.
2. It involves minimum statistical work. Therefore, there is no need for special
technical skills.
3. This method is less cost as consumer survey is avoided.
4. It is realistic as it is based on personal and first hand knowledge of salesmen.
5. This method is useful in forecasting the sales of new products.
Disadvantage.
1. It is almost completely subjective. If the salesmen have personal prejudices,
then the forecast will be baized.
2. It is useful only for a period of one year. It is not useful for long term
production planning.
3. Salesmen may not be aware of the changes that affect future demand.

2. Expert Opinion. (Business

Economics by V.G.Mankar page no 111)
Besides opinion survey, experts opinion can be taken by the firm. There are certain
categories of people who are in the know of the market. They know the consumers
responses to the product. These are salesmen, market consultant, professional
experts, distributors etc. These people are dealing in the products or have studied
market trends and consumers behavior for years; they know the future plans of the
consumers, their reactions to new product, demand for rival products, etc.
Advantages.
1. Forecast can made relatively quickly and cheaply.
2. In the case of new products, data may not be available or may be difficult to
collect. In such cases, this method is useful.
Disadvantages.
1. Opinion are subjective and hence not satisfactory.
2. Good and bad estimates are given equal weights.

3. Delphi Method.
A variant of the survey method is Delphi method. Under this method a panel is
selected to give suggestion to solve the problems in hand. Both internal and
external experts can be the members of the panel. Panel members are kept from
each other and express their views in an anonymous manner. There is also a
coordinator who acts as an intermediary among the panelist. He prepares the
questionnaire and sends it to the panelists. At the end of each round, he prepares a
summary report. On the basis of the summary report the panel members have to
give suggestions. This method has been used in the area of technological
forecasting. It has proved more popular in forecasting non-economic rather than
economic variable.

4. Consumer interview Method.

In this method the consumer are contact personally to know about their plans and
preference regarding the consumption of the product. A list of all potential buyers
would be drawn and each buyer will be approached and asked how much he plans
to buy the listed product in future. He would be asked the proportion in which he
intends to buy.

(B) Statistical Methods:

Statistical method is used for a long run forecasting. In this method, statistical and
mathematical techniques are used to forecast demand. This method relies on past
data.
1. Time series analysis or Trend projection method.
A well established firm would have accumulated data. These data are analyzed to
determine the nature of existing trend. Then this trend is projected into the future
and the results are used as the basis for forecast. This is called as time series
analysis. The data can be presented in tabular form or a graph.

2. Moving Average.
This method is based on the assumption that the future is the average of past
achievements. Hence based on past achievement future is predicted. When the
demand is stable this method can provide good forecast

3. Barometric technique.
Simple trend projections are not capable of forecasting turning points. Under
barometric method, present events are used to predict the directions of change in
future. This is done with the help of economic and statistical indicators.
Most commonly used indicators are
(i) Personal income
(ii) Agricultural income
(iii) Employment
(iv) Gross National income etc

4. Regression Analysis (Business

Economics by V.G.Mankar page no 120)
Regression analysis is a statistical technique which is widely used in different
scientific disciplines. It is a tool to measure or estimate the unknown value of one
variable from the known value of another variable. In demand estimation (short
period) and demand forecast(long period), it is a very useful technique to find out
the changes in the quantities of the product demanded, when other independent
variables, such as price, income, tastes, advertising, etc., changes. Suppose , two
variable X (say advertising expenditure) and Y (sales) are closely related, we can
find out with the help of regression equation the probable value of Y (sales) for a
given value of X (advertising expenditure).

Law of Diminishing Marginal Utility: (Industrial Economics and

Management S.P.Singh page no 145)
Total Utility.
Total Utility(TU) is the total satisfaction a person gains from all those units of a
commodity consumed within the given time period. The more units a commodity a
consumer consumes, greater will be total utility up to a certain point. As he/she
goes on increasing the consumption of the commodity he eventually reaches a point
of his/her maximum satisfaction consumption of any further units of the commodity
will lead to decline in his/her total utility.
Marginal Utility.
Marginal Utility (MU) is the additional satisfaction gained from consuming one extra
unit within a given period of time or as the utility derived from the marginal unit
consumed.
In other words MU is the utility of last unit or the addition to total utility by the
consumption of one additional unit of the commodity.
Law of Diminishing Marginal Utility:
The more we have of a thing the less we want additional increment of it.
In simple words, as a consumer goes on consuming a commodity the extra
satisfaction that he enjoys from consuming an additional unit goes on decreasing
with every successive unit. Thus, the Marginal Utility diminishes. When the marginal
utility is zero, point of saturation is reached and at this point the total utility is
maximum.

Law:
The additional benefit which a person derives from a given increase of his stock of
a thing diminishes with every increase in stock that he already has.
Marshell

Unit Total Utility Marginal Utility

Consumed (TU) (MU)

00 00 --
01 08 08
02 14 06
03 18 04
04 20 02
05 20 00
06 18 -02
07 15 -03
Certain Assumption related to Law of Diminishing Marginal Utility
The units of the commodity must be relevantly defined e.g., a cup of tea, a
bottle of soft drink etc.
The unit s must not be excessively small or large.
The consumers taste or preference must not change during the period of
consumption.
The consumption must be continues.
A break in continuity is necessary, the time interval between the
consumption of two units must be appropriately short.
The mental condition of the consumer must remain normal during the period
of consumption.

Elasticity of Demand:
(Managerial Economics by R.Cauvery page no 51)
Law of demand explains the direction of change in demand. A fall in price leads to a
increase in quantity demanded and vice-versa. But it does not tell us the rate at
which demand changes in price. Elasticity of demand explains the relationship
between a change in price and consequent change in amount demanded. Elasticity
of demand shows the extent of change in quality demanded to a change in price.
Definition.
The elasticity of demand in a market is great or small according as the amount
demanded increases much or little for a given fall in the price and diminishes much
or little for a given rise in price.
- Marshall
Elastic Demand
A small change in price may lead to a great change in quantity demanded. In this
case, demand is elastic.
Price in Rs. Quantity
Demanded of
Milk(in litres)
5.00 1
4.75 2
5.25 0.5
When price falls from Rs. 5.00 to Rs. 4.75, quantity demanded doubles from one
litre to two litres. On the other hand, when price increases from Rs. 5.00 to Rs. 5.25,
amount demanded falls to half litres. Therefore, demand is said to be more elastic.
Inelastic Demand
If a big change in price is followed by a small change in demand then the demand is
inelastic.

Price of Rice (in Amount Demanded

Rs.) (in Kg.)
10.00 20
5.00 21
15.00 19
When the price of rice has changed to a very great extent the quantity demanded of
rice has changed by a very small amount. Thus the demand is inelastic.

Degrees of Elasticity of Demand:

(Managerial Economics by R.Cauvery page no 52)
1. Perfectly or Infinitely elastic demand.
When a small change in price leads to an infinitely large change in quantity
demanded, it is called perfectly or infinitely elastic demand.

The demand curve DD1 is a horizontal straight line. It shows that at OP price any
amount is demanded and if price increases, the consumer will not purchase the
commodity.
2. Perfectly inelastic demand.
In this case, even a large change in price fails to bring about a change in quantity
demanded.

When price increases from OP to OP1 the quantity demanded remains the same. In
other words, the response of demand to a change in price is Nil. In this case E=0.
3. Relatively elastic demand.
Demand changes more than proportionately to a change in price. i.e., a small
change in price leads to a very big change in the quantity demanded. In this case E
> 1. The demand curve will be flatter.

4. Relatively inelastic demand.

Quantity demanded changes less than proportionately to a change in price. A large
change in price leads to a small change in amount demanded. Here E < 1. Demand
curve will be steeper.

When price falls from OP to OP 1 amount demanded increases from OQ to OQ 1 which

is smaller than the change in price.
5. Unit elasticity of demand.
The change in demand is exactly equal to the change in price. When both are equal
E = 1 and elasticity is said to be unitary.

When price falls from Op to OP1, quantity demanded increases from OQ to OQ 1. Thus
a change in price has resulted in an equal change in quantity demanded. So price
elasticity of demand is equal to unity.

Factors determining Elasticity of demand. (Managerial

Economics by R.Cauvery page no 61)
Elasticity of demand depends on many factors.
1. Nature of the commodity.
Elasticity or inelasticity of demand depends on the nature of the commodity i.e.,
whether the commodity is a necessity, comfort or luxury. Normally, the demand for
necessaries like salt, rice, etc is inelastic. On the other hand the demand for
comforts and luxuries is elastic.
2. Availability of substitutes.
Elasticity of demand depends on the availability or non-availability of substitutes. In
case of commodities which have substitutes, demand is elastic. But for goods which
have no substitutes, demand is inelastic.
3. Variety of Uses.
If a commodity can be used for several purposes, then it will have elastic demand;
eg electricity. On the other hand demand is inelastic for a commodity which can be
put to only one use.
4. Postponement of Demand.
If the consumption of a commodity can be postponed, then it will have elastic
demand. On the contrary, if the demand for a commodity cannot be postponed,
then demand is inelastic. The demand for rice (or medicine) cannot be postponed
while the demand for a cycle, umbrella can be postponed.
5. Amount of money spent.
Elasticity of demand depends on the amount of money spend on the commodity. If
the consumer spends a smaller proportion of his income on a commodity, then the
demand is inelastic. For example a consumer spends a little amount on matchboxes,
agarbattis(essence sticks). Even when price of matchbox goes up, demand will not
fall. Therefore, demand is inelastic. In case clothing, consumers spends a large
proportion of his income and an increase in price will reduce his demand for
clothing. So the demand is elastic.
6. Consumer Habits. (Economics for
managers by D.M.Mithani, Page no 128)
There are certain articles which have a demand on account of habit. If a consumer
is habituated or addicted to consuming a particular commodity, then the price of
the commodity however high it may rise, will not affect the demand for that
commodity. This will make the demand inelastic. For example, cigarettes, pan, bidi,
pan-masala, tobacco, etc.
7. Durability of the commodity. (Economics for
managers by D.M.Mithani, Page no 128)
In the case of durable goods, the demand generally tends to be inelastic in the short
run, e.g., furniture, bicycle, radio, etc. in the case of perishable commodities, on the
other hand, demand is relatively elastic, e.g., milk, vegetables, etc.
8. Ranges of price. (Business
Economics by V.G.Mankar, Page no 81)
Demand for very low priced goods and very high priced goods are inelastic.
Demand for goods with middle range prices tends to be more elastic.

Measurement of Elasticity:
(Managerial Economics by R.Cauvery page no 55)
For practical purpose, it is not enough to know whether the demand is elastic or
inelastic. It is more useful to find out the extent to which demand is elastic or
inelastic. Generally four methods are used to measure elasticity of demand.
1. Percentage Method.
It measures elasticity of demand by comparing the ratio of percentage of change in
the amount demanded to the percentage of change in the price of a commodity.
Marshell gives the following formula for measuring elasticity of demand.
Ed = Relative change in the amount demanded
Relative change in price

2. Total Outlay Method.

In this method we consider the change in expenditure on commodities due to a
change in price.
Case 1:
If a given change in price does not cause any change in the total amount of money
spent on commodity, then elasticity of demand is equal to unity.
Demand Schedule showing Unit Elasticity

Price in Rs Quantity Total Outlay or

Demanded Expenditure
4.50 4 Rs. 18
4.00 4 2 Rs. 18
3.00 6 Rs. 18
As price falls, quantity demanded increases; but the total outlay remains constant
at Rs. 18. Hence elasticity of demand is equal to unity.
Case 2:
If the total expenditure increases due to a fall in price, elasticity of demand is
greater than unity.
Demand Schedule showing Elasticity greater than Unity

Price in Rs Quantity Total Outlay or

Demanded Expenditure in Rs
4.50 6 27
4.00 7 28
3.00 10 30
When price falls, the total outlay increases. Therefore elasticity of demand is greater
than unity.
Case 3:
If a given change in price results in a fall in the amount spent, then elasticity of
demand is less than unity.
Demand Schedule showing Elasticity less than Unity

Price in Rs Quantity Total Outlay or

Demanded Expenditure in Rs
4.50 4 18
4.00 4 4 17
3.00 5 15
Here total outlay is declining even though quantity demanded is increasing. Hence
demand is said to be inelastic and elasticity coefficient is less than one.

3. Point Method or Geometric Method.

This method was also given by Marshell. In a straight line demand curve, elasticity
through point method is measured in the following way:
The straight line demand curve is extended to meet the two axis. Point P divides the
demand curve into two segments. Point elasticity at point P is calculated by the
ratio of the lower segment of the curve below the given point to the upper segment
i.e., PB .
PA

If the Demand curve is not a straight line the same method may be used by drawing
a tangent to the curve at the required point.

DD is the demand curve. If elasticity is to be measured at point P a tangent AB is

drawn to the point P. Elasticity of demand at point P is measured by using the
formula
Lower Segment of the Demand curve = PB
Upper Segment of the Demand curve PA

However, elasticity of demand is different at different points even in a straight line

demand curve.
 P is the midpoint of the straight line demand curve. Since PA = PB here PA =
1. Therefore,

PB
Elasticity of demand at P is unity.
Elasticity at point P1 = P1A < 1. Hence elasticity of demand at P1 is less than
one.
P 2B
Elasticity at demand at point P2 is greater than one since P2A > 1.
P 2B

4. Arc Method.
According to Baumol,
Arc elasticity is a measure of average responsiveness to price change exhibited by
a demand curve over some infinite stretch of the curve.
Since point method gives different results for the same change in price, economists
have devised Arc Method for measuring price elasticity of demand. The formula for
Arc elasticity of demand is
Original Quantity New Quantity
Elasticity of = Original Quantity + New Quantity
Demand Original Price New Price
Original Price + New Price

Q1 Q2 P1 P2
Q 1 + Q2 P1 + P2
or
Q P
Q 1 + Q2 P1 + P2
P1 and Q1 are the initial price and Quantity;
P2 and Q2 are the price and Quantity after change
Arc method is useful only when we have full information about the changes in price
and quantity demanded. Since only limited information is available about these
factors, midpoint formula has been suggested by economists to measure elasticity
of demand. This method uses the average of two prices and two quantities (initial
and final data) under consideration. The formula may be stated as follows:
Changes in Quantity Demanded
Sum of the Quantity
Elasticity of = 2
Demand Changes in Price
Sum of Price
2
i.e.,
q p
q 1 + q2 p 1 + p2
2 2

q p 1 + p2
q 1 + q2 2
 2 p

= q p 1 + p2
q 1 + q2 p
= q(p1 + p2)
p(q1 + q2)

Importance of Elasticity of Demand. (Managerial

Economics by R.Cauvery page no 62)
The concept of elasticity of demand is of much practical importance.
1. Price Fixation.
Each seller under monopoly and imperfect competition has to take into account
elasticity of demand while fixing the price for his product. If the demand for the
product is inelastic, he can fix a higher price.
2. Production.
Producers generally decide their production level on the basis of demand for the
product. Hence elasticity of demand helps the producers to take correct decision
regarding the level of output to be produced.
3. Distribution.
Elasticity of demand also helps in the determination of rewards for factors of
production. For example, if the demand for labour is inelastic, trade union will be
successful in raising wages. Same is applicable to other factors of production.
4. International trade.
Elasticity of demand helps in finding out the terms of trade between two countries.
Terms of trade refer to the rate at which domestic commodity is exchange for
foreign commodities. Terms of trade depends upon the elasticity of demand of two
countries for each others goods.
5. Public Finance.
Elasticity of demand of demand helps the government in formulating tax policies.
For example, for imposing tax on a commodity, the Finance Minister has to take into
account the elasticity of demand.