What is the Price Elasticity of Demand?
The price elasticity of demand is a calculation of the degree of change in a commodity's demand with respect to the price change of that commodity. The price elasticity of demand, in other words, is the rate of change in the quantity requested in response to the price change. It is sometimes denoted by Ep or PED. To understand the meaning of elasticity of demand, it is important to learn the methods of measuring the quantity.
Here, we will study the relative elasticity of demand types: price elasticity of demand, price elasticity formula, the elasticity of demand and supply, point elasticity of demand, etc.
Methods of Measuring Price Elasticity of Demand
Basically, there are four ways by which we can calculate the price elasticity of demand, and these are:
Percentage method
Total outlay method
Point method
Arc method
Percentage Method- Price Elasticity Demand
The Percentage method is one of the widely used methods for calculating demand price elasticities, where price elasticity is calculated in terms of the rate of the percentage change in the quantity requested to the percentage change in price.
The price elasticity of demand can, according to this approach, be mathematically expressed as -
PED = % change in quantity demanded / % change in price, where
\[ \text{change in quantity demanded} = \frac{\text{new quantity (Q2)} - \text{initial quantity (Q1)}} {\text{initial quantity (Q1)} \times 100}\]
\[ \text{change in price} = \frac{\text{new price ( P2)} -\text{initial price ( P1)}} {\text {initial price ( P1)} \times 100}\]
Therefore, \[PED=\frac{\Delta Q}{\Delta P}\times \frac{P1}{Q1}\]
For example, when the price of a commodity was Rs 10 per unit, the market demand for that commodity was 50 units a day. When the price of the product dropped to Rs 8, demand increased to 60 units. The price elasticity of demand can here be evaluated as -
PED =%change in quantity demanded/ % change in price, where
\[\frac{Q2-\frac{Q1}{Q1}}{p2-\frac{p1}{p1}}\times100\]
= \[\frac{60-\frac{50}{50}\times100}{8-\frac{10}{10}\times100}\]
= \[ \frac{20}{-20}\]
= -1
In comparison to supply price elasticity, demand price elasticity is often a negative number since the quantity requested and the product share price are inversely related. This implies that the higher the price, the lower the demand, and the lower the price, the greater the product demand.
Total Outlay Method
Professor Alfred Marshall developed the total outlay method, also known as the overall cost method of calculating price demand elasticity. The price elasticity of demand can, according to this approach, be calculated by comparing the total expenditure on the commodity before and after the price adjustment.
We can get one of three results when comparing the expenditure. They are the
Request elasticity would be greater than the unity of (Ep > 1)
If total expenditure rises with a decrease in price and decreases with a rise in price, the value of the PED is greater than 1. Here, price rises, and overall spending or outlays shift in the opposite direction.
The elasticity of demand will be equal to unity (Ep = 1)
If, in response to a rise in the price of the commodity, the overall expenditure on the commodity remains unchanged, the value of the PED would be equal to 1.
The elasticity of demand will be less than unity (Ep < 1)
The value of PED would be less than 1 if total spending decreases with a decline in price and rises with a rise in price. Here, commodity prices and overall spending are going in the same direction.
When the information from the above table is plotted in the graph, we get a graph like the one shown below.
On the X-axis, gross outlay or cost is calculated in the graph while the price on the Y-axis is measured. The transfer from point A to point B demonstrates elastic demand in the figure, as we can see that overall spending has risen with price decreases.
As total expenditure has remained unchanged with the change in price, the shift from point B to point C demonstrates unitary elastic demand. Likewise, as overall expenditure, as well as price, has decreased, the shift from point C to point D indicates inelastic demand.
Price Elasticity on a Linear Demand Curve
If the demand curve is linear in nature, the PED is determined simply by applying the above expression, i.e.
\[PED = \frac{\text{lower segment of the demand curve}}{ \text{upper segment of the demand curve}}\]
MN is a linear demand curve in the figure and P is the midpoint of the curve.
Therefore, at point P,
\[PED = \frac{\text{lower segment of the demand curve}}{ \text{upper segment of the demand curve}}\]
Price Elasticity on a Non-linear Demand Curve
If the demand curve is non-linear or convex in nature, then at the point where the PED is to be determined, a tangent line is drawn. Then again, PED is measured as
\[PED = \frac{\text{lower segment of the demand curve}}{ \text{upper segment of the demand curve}}\]
FAQs on Price Elasticity: Measurement and Application
1. What are the methods of measuring price elasticity?
There are several methods for measuring price elasticity of demand, such as:
- the percentage or proportionate method
- the total expenditure method
- the point method
- the arc method
2. How to measure price elasticity?
To measure price elasticity of demand, use this formula: $PED = \frac{\% \ change\ in\ quantity\ demanded}{\% \ change\ in\ price}$. Calculate the percentage changes, divide quantity change by price change, and interpret the result to understand consumer responsiveness.
3. What are the three measures of elasticity?
The three main measures of elasticity in economics are:
- Price elasticity of demand (PED)
- Income elasticity of demand (YED)
- Cross-price elasticity of demand (XED)
4. What if PED is greater than 1?
If the price elasticity of demand (PED) is greater than 1, demand is considered elastic. This means consumers are highly sensitive to price changes, so a small price change causes a larger proportional change in the quantity demanded of the product.
5. What is the total expenditure method in measuring price elasticity?
The total expenditure method measures price elasticity by observing how total spending on a good changes when price changes.
- If total expenditure rises as price falls, demand is elastic.
- If it falls, demand is inelastic.
6. What is the point method of measuring price elasticity?
The point method measures price elasticity of demand at a specific point on the demand curve. It calculates elasticity using the derivatives of price and quantity, or small percentage changes, making it precise at that point rather than over a range.
7. What is the arc method in elasticity measurement?
The arc method calculates price elasticity of demand between two points on a demand curve. Instead of using initial or final values alone, it averages the changes in price and quantity, making the result less biased for larger changes in price elasticity.
8. What factors affect the measurement of price elasticity?
Several factors affect measuring price elasticity of demand, including:
- availability of substitutes
- necessity versus luxury
- consumer income level
- definition of the market
9. Can price elasticity of demand ever be negative?
Yes, the price elasticity of demand is usually negative because price and quantity demanded move in opposite directions by law of demand. For example, as price rises, people buy less, so elasticity is typically a negative value, but often we discuss the absolute value.
10. Why is measuring price elasticity important?
Measuring price elasticity is important for:
- businesses setting prices
- governments planning taxes
- predicting consumer reaction
11. What does a price elasticity less than 1 indicate?
A price elasticity of demand less than 1 shows inelastic demand. This means that a change in price leads to a smaller percentage change in quantity demanded, so consumers are not very responsive to price changes for that product.
