PRICE ELASTICITY OF DEMAND Q) Defne price elasticity o !e"an!# 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 is the 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 in uantity demanded Percentage change in the price !", #hange in uantity demanded 'nitial uantity demanded #hange in uantity uantit y price 'nitial price
Ed =
* p*P
=
$ p
$ %&& . p $ %&& P
P
E+ample Price of a commodity has gone do-n from "s.%&& to "s.&. /s a result the uantity demanded has gone up from 0&& to 1&&. Solution Ed = $ P p = 0&& &
$
%&&.. 0&&
=
0
Q) E$plain %ario&s 'in!s (!eree) o price elasticity o !e"an!* A) Price elasticity of demand is the measurement of responsiveness of demand to change in price. 2emand for different goods responds differently to change in price. 3or instance, demand for salt does not respond or change at all even if its price falls by &4 -hereas demand for apples responds very much -hen its price falls by 0&4 only. !n the basis of change in demand as a result of changes in price, elasticity of demand can be classified into the follo-ing categories (i) (i) Elas Elasti ticc 2em 2eman and d or or Mor Moree tha than n uni unitt ela elast stic ic dema demand nd (Ed 5%) if percentage change in uantity demanded is more than the percentage change in price the commodity is said to have more than unit elastic (Ed 5%) or Elastic
demand. 3or e+ample, if price falls by %&4, the uantity demanded -ill go up more than %&4. 6he demand for lu+ury goods (/#, 67, refrigerator, #ars) is elastic. Price
Demand
%&
0&
1&
'n the diagram, 2emand curve is an elastic demand curve. 8hen price declines from !P to !P%, demand increases from ! to !%, the change in price is only PP%, but the change in demand is !% -hich is much more than the change in price. 6he slope of this curve is more inclined to-ards !9 : a+is or it is a flatter curve. (ii) 'nelastic 2emand !" ess than unit elastic demand (Ed <%) 8hen the percentage change in uantity demanded is less than the percentage change in price, it is said to be less than unit * inelastic demand. 3or e+ample, if price falls by &4, the uantity demanded -ill go up to by 0&4. 6he slope of the inelastic demand curve is steeper. Price
Demand
%&&
%&&
&
%%&
'n the diagram, 2emand curve is an inelastic demand curve. 8hen price d eclines from !P to !P%, demand increases from ! to !% only. 6hus it is evident that the change in demand is much less in comparison to the change in price.. the demand for necessary goods (basic foods items) is inelastic. (iii) nitary elastic demand (Ed =%) 8hen the percentage change in uantity demanded is eual to Price Demand the percentage change in price, it is said to be unitary elastic demand. 6he unitary elastic demand %&& %&& curve is a rectangular hyperbola and the area of all rectangles formed on this curve is the same. 3or ?& %%& e+ample, if price falls by %&4, the uantity demanded -ill go up to by 0&4. (iv) Perfectly elastic 2emand (Ed >%) 8hen the demand for a commodity e+pands (rises) or contracts (falls) to any e+tent -ithout change in price, the demand for the commodity is said to be perfectly elastic.
Price
Demand
%&
%&
%&
0&
3or the diagram, it is clear that such a demand curve is a hori@ontal parallel to !9 : a+is. 'n the diagram, price is !P, but demand can be !, !%, !0 etc. (v) Perfectly inelastic demand (Ed =&) 8hen the demand of a commodity does not change as a result of change in its price, the demand is said to be perfectly inelastic demand. Aere the elasticity of demand is eual to @ero. 6his happens in case of goods -hich are absolutely essential liBe demand for a rare medicine or some very bad case of addiction to undesirable products liBe opium. Price
Demand
%&
0&
%&
0&
C&
0&
6he perfectly inelastic demand curve is a vertical straight line parallel to !D : a+is. /s it is clear from the diagram, price may be !P or !P% or !P0, but the demand -ill be !. 'n other -ords, there is no effect of changes in the price on demand.
Q) I t+o !e"an! c&r%es intersect, at t-eir point o intersection, +-ic- c&r%e -as -i-er elasticity o !e"an!# A) 'f t-o demand curve intersect, at their point of intersection, the elasticity associated -ith the flatter demand curve is higher. 6his is e+hibited in the belo- diagram 6he demand curves 22 and 2%2% intersect at point EF. at this point, !P is the price of the product. 6he claim is that, at price !P%, the elasticity is greater along the flatter demand curve 2%2% because the original uantity demanded is same, eual to ! along both the demand curves. /nd if there is a decrease in price, say to !P%, the uantity demanded increases more along the flatter demand curve (by amount ! to !0 as compared to ! to !%, along 22 curve). 6his implies that, -hile, the percentage change in uantity demanded is greater along 2%2%. therefore, price elasticity associated -ith 2%2% is higher.
.) /-at actors a0ect t-e "anit&!e o price elasticity# (i)
(ii)
(iii)
(iv) (v) (vi)
/vailability of close substitute 'f close substitutes of a product are readily available, its price elasticity of demand is liBely to be high, because even a very small increase in price -ill maBe consumers s-itch to other p roducts in a big -ay. !ther-ise, in the absence of close substitutes, the elasticity is liBely to be small (inelastic). Gature of commodity More generally, the demand for essential products is liBely to be inelastic. !n the other hand, Hlu+uryI items are relatively dispensable. Aence the demand for these items is liBely to be relatively elastic. Proportion of total e+penditure spent on the product 'f the e+penditure spent on the product constitutes a very small fraction of the total e+penditure on all goods and services -e consume, then the price elasticity is liBely to be small ('nelastic). 6he demand for salt is an e+ample. !n the other hand, if it is a high priced item and taBes a maJor portion of our total e+penditure, our demand for it is more sensitive to a change; that is elasticity of demand is liBely to be high (Elastic). Aabits 3or people -ho are habitual is liBely of a commodity has inelastic demand. 6ime period /ll other things remaining the same, the longer the time period, more elastic is the demand for any product. ses of a commodity the greater the number of uses of a commodity the higher -ill be its price elasticity.
Q) /-at are t-e !i0erent "et-o!s o "eas&rin price elasticity o !e"an!# A) 6here are three methods of measuring price elasticity of demand a. 6otal e+penditure * 6otal outlay method b. Proportional (Percentage) Method c. Point Method * Keometric Method I. Total expenditure / Total outlay method 6his method -as propounded by prof. Marshall. 6his method measures the elasticity of demand by measuring the effect on total e+penditure as a result of a change in its price. 6otal e+penditure is calculated by multiplying the uantity of the commodity purchased -ith its price. (6E = 6 $ P) (i) nit elastic 2emand 'f a fall or PRICE QUANTITY T!TA" rise in price leaves the total DEANDED E#PENDITURE e+penditure unaffected, elasticity %& %& %&& of demand is unity (Ed = %). 't is 0& %&& sho-n belo-
(ii)
More than unit elastic demand if a fall in price leads to increase in total e+penditure or a rise in price reduces the total
PRICE
QUANTITY DEANDED
T!TA" E#PENDITURE
%&
%& 0&
%&& %&&
(iii)
e+penditure, the elasticity of demand is said to be more than unity (Ed5%). 6here is a inverse relationship bet-een price and total e+penditure. ess than unit elastic demand 8hen a fall in price reduces total e+penditure or a rise in price increases it, the elasticity of demand is said to be less than unity PRICE QUANTITY T!TA" (Ed<%). 6here is a same DEANDED E#PENDITURE relationship bet-een price %& %& %&& and total e+penditure. 0& %&&
II. Proportionate or Percenta$e ethod 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. Price Elasticity of demand (Ed) = Percentage change in uantity demanded Percentage change in the price
!", #hange in uantity demanded 'nitial uantity demanded #hange in uantity price 'nitial price
• • • • •
Ed =
* p*P
=
$ p
$ %&& . p $ %&& P
P
8hen the ans-er is one, demand is unit elastic. 8hen the ans-er is more than one, demand is elastic. 8hen the ans-er is less than one, demand is inelastic. 8hen the ans-er is @ero, demand is perfectly inelastic. 8hen the ans-er is infinite, demand is perfectly elastic.
III. %E!ETRIC / P!INT ET&!D Elasticity of demand at a point on a straight line demand curve can be estimated -ith the help of point method. 'n the given diagram point EF is given on the straight line demand curve /L having intercepts / and L respectively on the price a+is and uantity a+is respectively. Point elasticity, at a certain point along a straight line demand curve, is eual to the lo-er segment divided by the upper segment of the demand curve at that point. Ed at point E on the straight = o-er Segment EL Segment belo- the point line demand curve pper segment /E Segment above the point
%) 'f the lo-er segment is eual to upper segment (EL = /E) elasticity of demand is eual to one. 6his -ill be so -hen point is located in the middle of the line. 0) 'f the lo-er portion EL is greater than upper portion /E, elasticity of demand -ill be greater than one. 6his -ill happen -hen the point is located in the upper half of the curve. C) 'f lo-er portion is less than upper portion, elasticity of demand -ill be less than one. 't so happens -hen point is located in the lo-er half. 1) 'f the point is located on !9 a+is, elasticity of demand -ill be @ero because lo-er segment is @ero. ) 'f the point is located on the !D a+is, elasticity of demand -ill be infinite because upper segment is eual to @ero.
