Methods of Measuring Price Elasticity of Demand | Elasticity of Demand Class 12

 Concept of Elasticity of Demand:

• The elasticity of demand is a “measurement of the relative change in quantity demanded in response to the relative change in price”
• Because of the elasticity of demand, we are able to measure the percentage change in demand in response to the percentage change in price
• This elasticity of demand indicates a relationship between percentage change in demand and percentage change in price.
• According to Prof. Marshall, “Elasticity of demand is great or small according to the amount demanded which rises much or little for a given fall in price and quantity demanded falls much or little for a given rise in price.”

Types of elasticity of demand

1. Income Elasticity of Demand.
2. Cross Elasticity of Demand.
3. Price Elasticity of Demand.
   

Income Elasticity: Income Elasticity of demand refers to a change in quantity demand for a commodity due to the change in the income of consumers, other factors remain constant. It can be expressed as follows:

Cross Elasticity: Cross Elasticity of demand refers to a change in quantity demand for a commodity due to the change in the price of complementary goods. Eg. Car and Petrol.

Price Elasticity: Price Elasticity of demand refers to a change in quantity Demand for a commodity due to a change in its price, other factors remain the same.

Types of Price Elasticity of Demand:

Perfectly Elastic Demand: When there is a single change or no change in the price of a commodity but demand for a commodity change infinitely. It is called perfectly elastic demand. E.g. if the price change by 1% then demands change by more & more.

In figure 3.11, the demand curve DD is a horizontal line parallel to the X-axis indicating perfectly elastic demand.

Perfectly Inelastic Demand: When a change in the price of a commodity has no effect on the quantity demand of the commodity, it is called relatively inelastic demand. For Example, if demand changes by 1% then demand changes by more & more.

In figure 3.12, when the price rises from OP to OP1 or when the price falls from OP to OP2, demand remains unchanged at OQ. Therefore, the demand curve is a vertical straight line parallel to the Y-axis, indicating perfectly inelastic demand.

Relatively elastic demand: When the percentage change in demand for a commodity is more than the percentage change in the price of the commodity, then it is known as relatively elastic demand. Example If demand change by 20% then the price change by 10%

 In figure 3.14, when the price falls from OP to OP1 (50%), demand rises from OQ to OQ1 (100%). Therefore, the demand curve has a flatter slope.

Relatively inelastic Demand: When the percentage change in demand for a commodity is less than the percentage change in the price of the commodity, it is known as relatively inelastic demand. For example, If demand change by 20% then price change by 40%

 In figure 3.15, when the price falls from OP to OP1 (50%), demand rises from OQ to OQ1 (25%). Therefore, the demand curve has a steeper slope.

Unitary elastic demand: When the percentage change in demand for a commodity is equal to the percentage change in the price of the commodity, it is known as unitary elastic demand. For example, If demand changes by 50% the price also changes by 50%.

 In figure 3.13, when the price falls from OP to OP1 (50%), demand rises from OQ to OQ1 (50%). Therefore, the slope of the demand curve is a 'rectangular hyperbola'

Factors influencing the elasticity of demand :

1. Nature of the commodity: The demand for necessaries is inelastic demand and demand for luxuries and comfort is elastic demand.
2. Availability of substitutes: If the commodity has a number of substitutes it will have elastic demand. If the commodity has no substitute like railways services it will have inelastic demand.
3. The number of uses: Single-use goods have a less elastic demand. Multi-use goods have more elastic demand, For example, coal, electricity, etc.
4. Habits: Habits make a demand for certain goods inelastic. For example cigarettes, drugs, etc.
5. Durability: The demand for durable goods is relatively elastic. For example, furniture, washing machine, etc. The demand for perishable goods is inelastic. For example, milk, vegetables, etc.
6. Complementary commodities: A commodity having several uses has more elastic demand. For example, electricity can be used for lighting, cooking, heating, etc.
7. Income of the consumer: If the consumer income is more demand will be inelastic and when consumer income is less demand will elastic.
8. Urgency: If wants are more urgent, demand becomes relatively inelastic. If wants can be postponed, demand becomes relatively elastic.
9. Time period: Elasticity of demand is always related to a period of time. It varies with the length of the time period. Generally speaking, the longer the duration of the period greater will be the elasticity of demand and vice-versa.

Importance of Elasticity of Demand :

1. Importance to the producer: - It is very useful for the producer in taking price decisions. It means deciding whether to charge higher prices or lower prices. If the demand for the product is inelastic then the producer always charges a higher price. And if the demand is elastic then the price has to be below.
2. Importance to the Government: - The knowledge of the concept of elasticity of demand helps the government in determining taxation policy etc. If the demand is inelastic the governments impose a higher tax and if the demand is elastic the governments impose less tax.
3. Importance to factor pricing: - this concept is very useful for determining the factor reward. Factor, which has an elastic demand, is paid fewer wages. On the other hand, labor that has inelastic demand is paid a higher reward.
4. Importance in Foreign Trade: - If export from a country has an inelastic demand then the exporter can fix higher prices to earn more foreign exchange.
5. Public Utilities: In the case of public utilities like railways which have inelastic demand, Government can either subsidize or nationalize them to avoid consumer exploitation.
6. The proportion of expenditure: When a consumer spends a very small portion of his income on a commodity demand will be inelastic and vice versa e.g. newspaper.

Methods of Measuring Price Elasticity of Demand :

Ratio or Percentage method :

The ratio method is developed by Prof. Marshall. According to this method, the elasticity of demand is measured by dividing the percentage change in demand by the percentage change in price. The percentage method is also known as the Arithmetic method. Price elasticity is measured as:

Total Expenditure Method :

This method was developed by Prof. Marshall. In this method, the total amount of expenditure before and after the price change is compared. Here the total expenditure refers to the product of price and quantity demanded.

Total expenditure = Price × Quantity demanded

In this connection, Marshall has given the following propositions :

A) Relatively elastic demand (Ed >1): When a given change in the price of a commodity's total outlay increases, the elasticity of demand is greater than one.

B) Unitary elastic demand (Ed = 1): When price falls or rises, total outlay does not change or remains constant, the elasticity of demand is equal to one.

C) Relatively inelastic demand (Ed<1)

When a given change in the price of a commodity's total outlay decreases, the elasticity of demand is less than one.

6 per unit and quantity 5 per unit demanded is 10 units. Therefore, the total expenditure incurred is ` 60. When price falls to ` 5 quantity demanded rises to 20 units, the total expenditure incurred is ` 100. In this case, the total outlay is greater than the original expenditure. Hence, at this stage, the elasticity of demand is greater than one. (Ed >1) that is relatively elastic demand.

In case ‘B’, the original price is ` 4 per unit, and the quantity demanded is 30 units. Therefore total expenditure is ` 120. When price falls to ` ‘3’ per unit quantity demanded rises to 40 units. Total expenditure incurred is ` 120. In this case, the total outlay is the same (equal) to the original expenditure. Hence, at this point, the elasticity of demand is equal to one (Ed = 1) which is unitary elastic demand.

In case ‘C’, the original price is ` 2 per unit, and the quantity demanded is 50 units. Therefore total expenditure is ` 100. When price falls to ` 1 per unit, quantity demand rises to 60 units and total expenditure incurred is ` 60. In this case, the total outlay is less than the original expenditure. Hence, the elasticity of demand is less than one (Ed<1)

Point method or Geometric Method :

Prof. Marshall has developed another method to measure the elasticity of demand, which is known as the point method or geometric method. The ratio method and total outlay methods are unable to measure the elasticity of demand at a given point on the demand curve.

At any point on the demand curve, the elasticity of demand is measured with the help of the following formula:

what is the elasticity of demand, type of elasticity of demand, type of price elasticity demand, Methods of Measuring Price Elasticity of Demand, Elasticity of Demand, types of price elasticity of demand, economics notes, elasticity 

Reference: MHSB Books 

For Other Subjects Click Here