Measurement of price elasticity of demand
Measurement of price elasticity of demand
The elasticity of demand devices a technique to assign a numerical value to the responsiveness of a change in quantity demanded of a good to a given change in its price. On this basis, there are different methods to measure the price elasticity of demand which are explained below.
Total expenditure method: In this method, the price elasticity is measured by comparing the total expenditure of the consumers before and after variations in price. We measure price elasticity by examining the change in total expenditure as a result of a change in the price and quantity demanded a commodity.
1. When total expenditure increases with the fall in price and decreases with a rise in price, then the PED is greater than one.
2. When the total expenditure remains the same, either due to the rise or fall in price, the PED is equal to one.
3. When total expenditure decreases with the fall in price and increases with the rise in price, the PED is lesser than one.
From the diagram it is clear:
1. From A to B, price elasticity is greater than one.
2. From B to C price elasticity is equal to one.
3. From C to D price elasticity is less than one.
Percentage Method:
According to Dr. Marshall, the price elasticity of demand is the ratio of the percentage change in the amount demanded to the percentage change in the price of the commodity. This method is also known as the ‘Flux Method’ or ‘Proportionate Method’ or ‘Mathematical Method’.
The elasticity of Demand (Ed) = Percentage change in quantity demanded / Percentage change in Price
where
q= initial quantity demanded
p = initial price
Δq= change in quantity demanded
Δp= change in price
p = initial price
Δq= change in quantity demanded
Δp= change in price
If EP>1, demand is elastic.
If EP< 1, demand is inelastic.
If Ep= 1, demand is unitary elastic.
for example
If EP< 1, demand is inelastic.
If Ep= 1, demand is unitary elastic.
for example
Price | Quantity |
10 | 100 |
12 | 80 |
where
P=10
Q=100
ΔP=2
ΔQ=20
Price | Quantity |
10 | 100 |
12 | 50 |
where
P=10
Q=100
Δ P=2
ΔQ=50
Q=100
Δ P=2
ΔQ=50
ED=2.5
In this case, elasticity is more than one and relatively elasticity demand.
price | quantity |
10 | 100 |
12 | 94 |
where
P=10
Q=100
Δ P=2
Δ Q=6
ED=.3
In this case, elasticity is less than one and relatively inelasticity demand.
If the proportional change in quantity demanded and proportional change in price is equal, then the price elasticity of demand will be equal to one and unitary elasticity demand.
If the proportional change in quantity demanded is more than the proportional change in price, then the price elasticity of demand will be more than one and relatively elasticity demand.
If the proportional change in quantity demanded is less than the proportional change in price, then the price elasticity of demand will be less than one and relatively inelasticity demand.
Point Elasticity Or Geometrical Method: The point method measures the price elasticity of demand at different points on a demand curve. This method was also selected by Dr. Marshall. It is used to measure small changes in both price and demand.
The demand curve is a linear or straight-line demand curve. When a point is plotted on the demand curve, it divides the curve into two segments. Elasticity is measured by the ratio of the lower segment of the demand curve below the given point to the upper segment of the curve above the point.
It is clear from the diagram that at point A, Lower segment of the demand curve is more than that of the upper segment of the demand curve, hence, elasticity is more than one [Ed>1]
At point B, the Lower and upper segment of the demand curve is equal, hence, elasticity is equal to one. [Ed=1]
At point C, the lower segment of the demand curve is less than the upper segment of the demand curve, hence, elasticity is less than one. [Ed<1]
On the top edge of the demand curve, elasticity is infinite and on the bottom edge of the demand curve, elasticity is zero.
Even if the demand curve is not a straight line, the above formula will apply.
Arc Elasticity Method: This method is suggested to measure large changes in both price and demand. In Arc elasticity, we express the price change as a proportion of the average of the initial price and change in price; and similarly, we express the change in the quantity demanded as a proportion of the average of the initial and the changed quantity. Thus, it is the average elasticity over a segment or range of the demand curve.
In the words of Baumol, "Arc elasticity is a measure of the average responsiveness to price changes exhibited by a demand curve over some finite stretch of the curve." Any two points on a demand curve make an arc that measures the elasticity over a certain range of prices and quantities.
ΔQ= Change in quantity
ΔP= Change in price
P1+P2= Initial price+ New price
Q1+Q2=Initial quantity+ New quantity
ΔP= Change in price
P1+P2= Initial price+ New price
Q1+Q2=Initial quantity+ New quantity
If P1= 10
P2=5
Q1=20
Q2=30
By substituting the values into the equation, we can find out Arc elasticity of demand.
P2=5
Q1=20
Q2=30
By substituting the values into the equation, we can find out Arc elasticity of demand.
In this diagram, in order to measure the arc elasticity between two-point A and B on the demand curve, we have to take the average of prices OP1 and OP2 and also the average quantities of Q1 and Q2.
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