Page 56 - DECO101_MICRO_ECONOMICS_ENGLISH

Unit 4: Elasticity of Demand

If e > 1, demand is said to be elastic, if e = 1, demand is unitary elastic and if e < 1, demand Notes
p p p
is inelastic. The numerical value of elasticity helps to know about responsiveness of demand to
change in price.

Example: A person has constant income at $3000. The present price of a good is $10 and
present quantity demanded is 125 units per month. The price falls to $9 and a large quantity of
150 units per month is likely to be demanded. What is the arc price elasticity over this range of
the demand curve?
Solution
+
25 10 9
e = × = − 1.73
p − 1 125 150
+
It indicates that quantity expands by 1.73% for each 1% fall in price over the relevant range of the
demand curve.

Task From the demand function Q = 600/P, show that the total expenditure
remains unchanged as price falls. Estimate elasticity of demand along the demand curve at
P = ` 4 and P = ` 6.

Caselet Price Gouging takes you Home

icture this. It is raining and you are caught inside a mall after a long shopping
expedition. The auto drivers want twice the “normal” fare to take you home. Is life
Punfair? Or is pure economics at play?
You know that price is determined by demand and supply. If demand goes up with
supply remaining same, prices ought to go up. And we know that the rain has increased
the demand for autos — people who would have otherwise walked or travelled by public
transport now want to hire an auto. The increased demand ought to increase the hire
charges, considering the supply of autos remain the same.
This does not, however, consider fairness of the price. You may argue that several people
who cannot afford to hire an auto for the twice the “normal” fare will be priced out of the
market. That is, of course, partially true.
If the rates are way too high, very few will hire the auto. This denies the auto drivers a good
chance to make more money. The sensitivity to price (or elasticity of demand) will ensure
that there is no intense price gouging.
The question still remains: Should auto drivers charge higher prices during rainy days or
such other market conditions? Suppose autos ply only on metered rate. You will agree that
driving on rainy days is more difficult than driving on other days. The risk for the auto

driver is higher but his return (metered fare), the same. There is, hence, no incentive for
auto drivers to work on rainy days. This would drive several autos out of the market. It
means you can hire an auto at “normal” fare… if you are lucky enough to get one!
So, consider price gouging (or call it free market pricing if you will) as a means to keep the
autos’ supply high… enough to get you home, if you agree on the price. This does not, of
course, justify unfair prices on regular days as well!
Source: www.thehindubusinessline.com

LOVELY PROFESSIONAL UNIVERSITY 51