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PRICE ELASTICITY OF DEMAND
Q) Define price elasticity of demand?A) Price elasticity of
demand indicates the magnitude of change or the degree of
responsiveness of demand for a commodity to a change in its
price. Mathematically, it isthe ratio of proportionate (percentage)
change in demand to proportionate (percentage)
change in price. Symbolically, it is defined as;
Price Elasticity of demand (Ed) = Percentage change in quantity
demanded
Percentage change in the price
OR,
Change in quantity demanded q * 100
Initial quantity demanded Q.
Change in quantity price p * 100
Initial price P
Ed = q/Qp/P
= q * Pp Q
Example: Price of a commodity has gone down from Rs.100 to
Rs.50. As a result thequantity demanded has gone up from 200 to
400.
Solution:Ed = q * P
p Q
= 200 * 100.. = 2
50 200
Q) Explain various kinds (degree) of price elasticity
ofdemand.A) Price elasticity of demand is the measurement of
responsiveness of demand to changein price. Demand for different
goods responds differently to change in price. For instance,demand
for salt does not respond or change at all even if its price falls
by 50% whereasdemand for apples responds very much when its price
falls by 20% only. On the basis of
change in demand as a result of changes in price, elasticity of
demand can be classified into
the following categories:(i) Elastic Demand or More than unit
elastic demand (Ed >1): if percentage
change in quantity demanded is more than the percentage change
in price
the commodity is said to have more than unit elastic (Ed >1)
or Elastic
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demand. For example, if price falls by 10%, the quantity
demanded will go
up more than 10%. The demand for luxury goods (AC, TV,
refrigerator,
Cars) is elastic.
Price Demand
10 20
5 40
In the diagram, Demand curve is an elastic demand curve. When
price declines from OP to
OP1, demand increases from OQ to OQ1, the change in price is
only PP1, but the change indemand is OQ1 which is much more than
the change in price. The slope of this curve is
more inclined towards OX axis or it is a flatter curve.
(ii) Inelastic Demand OR Less than unit elastic demand (Ed
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(i) Availability of close substitute: If close substitutes of a
product are readily
available, its price elasticity of demand is likely to be high,
because even a
very small increase in price will make consumers switch to other
productsin a big way. Otherwise, in the absence of close
substitutes, the elasticity is
likely to be small (inelastic).
(ii) Nature of commodity: More generally, the demand for
essential products islikely to be inelastic. On the other hand,
luxury: items are relatively
dispensable. Hence the demand for these items is likely to be
relatively
elastic.(iii) Proportion of total expenditure spent on the
product : If the expenditure
spent on the product constitutes a very small fraction of the
total
expenditure on all goods and services we consume, then the price
elasticity
is likely to be small (Inelastic). The demand for salt is an
example. On theother hand, if it is a high priced item and takes a
major portion of our total
expenditure, our demand for it is more sensitive to a change;
that is
elasticity of demand is likely to be high (Elastic).
(iv) Habits : For people who are habitual is likely of a
commodity has inelasticdemand.
(v) Time period : All other things remaining the same, the
longer the timeperiod, more elastic is the demand for any
product.
(vi)Uses of a commodity : the greater the number of uses of a
commodity
the higher will be its price elasticity.
Q) What are the different methods of measuring priceelasticity
of demand?A) There are three methods of measuring price elasticity
of demand:
a. Total expenditure / Total outlay method
b. Proportional (Percentage) Methodc. Point Method / Geometric
Method
I. Total expenditure / Total outlay method: This method was
propounded by prof.
Marshall. This method measures the elasticity of demand by
measuring the effect on total
expenditure as a result of a change in its price. Total
expenditure is calculated bymultiplying the quantity of the
commodity purchased with its price. (TE = TQ * P)
(i) Unit elastic Demand: If a fall or
rise in price leaves the total
expenditure unaffected, elasticityof demand is unity (Ed = 1).
It is
shown below:
(ii) More than unit elastic demand :
if a fall in price leads to
increase in total expenditure ora rise in price reduces the
total
expenditure, the elasticity of
PRICE QUANTITY
DEMANDED
TOTAL
EXPENDITURE
10 10 100
5 20 100
PRICE QUANTITY
DEMANDED
TOTAL
EXPENDITURE
10 10 100
5 20 100
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1) If the lower segment is equal to upper segment (EB = AE)
elasticity of demand is
equal to one. This will be so when point is located in the
middle of the line.2) If the lower portion EB is greater than upper
portion AE, elasticity of demand will
be greater than one. This will happen when the point is located
in the upper half of
the curve.
3) If lower portion is less than upper portion, elasticity of
demand will be less thanone. It so happens when point is located in
the lower half.
4) If the point is located on OX axis, elasticity of demand will
be zero because lower
segment is zero.
5) If the point is located on the OY axis, elasticity of demand
will be infinite becauseupper segment is equal to zero.
