Note on Measurement and Determinants of Price Elasticity of Demand

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MEASUREMENT OF PRICE ELASTICITY OF DEMAND

There are three methods of measuring price elasticity of demand. They are:

  • Total Outlay Method
  • Point Method
  • Arc Method

 

Total Outlay Method

The measure of price elasticity of demand measuring the total expenditure made on the consumption of goods & services before & after the change in the price is called toral outlay method. When the price of goods changes, total expenditure made on the goods & services may increase or decreases or remains same.

According to Alfred Marshall, "Elasticity of demand can be measured by considering the change in price and the subsequent change in the total quantity of goods purchased and the total amount of money spent on it".

Price elasticity of demand can be measured on the following three bases:-

  1. Elasticity of Demand Greater than Unitary (Ep>1)

If the total expenditure increases due to a small fall in price & total expenditure decrease due to rise in price then elasticity of demand will be greater than unity. Thus, there is negative relationship between price of the commodity & total expenditure. Hence, the total expenditure and price of a commodity are inversely related to each other.

  1. Elasticity of Demand Equal to Unitary (Ep=1)

If the total expenditure made by the consumer on a commodity doesn't change with any rise or fall in price of the commodity then elasticity of demand will be equal to unity

  1. Elasticity of Demand Less then Unitary (Ep<1)

If the total expenditure of a commodity falls due to the fall in price, then the price elasticity of demand is said to be less than one in this state. Hence, both total expenditure and price move in the same direction.

 

The above cases are prescribed with the table below:

  Price (in Rs.)       Quantity demanded (in kg.)        Total Expenditure (in Rs.)     Elasticity
         10                         1                       10       Ep>1
          8                         2                       16
          6                         4                       24       Ep=1

          4                         6                       24
          2                         8                       16       Ep<1

          1                        10                       10

In the given table, quantity demanded of a commodity is increasing serially 1, 2, 4, 6, 8 and 10 as the price of a commodity is decreasing 10. 8. 6. 4. 2 and 1 respectively. In the column of total expenditure, it is rising at first and remains constant at certain then later it is decreasing. It shows all three cases based on the price elasticity of demand. These conditions are also mentioned with the help of a diagram.

 

s

In the above graph, total expenditure is measured along X-axis and price is measured along Y-axis respectively. The points A and B show the inverse relation between price and total expenditure, where the price increases and total expenditure falls and vice versa. Next point B and C seems to be parallel to price, where there is no change in total expenditure even there is a change in price. Point C and D show the positive relation between price and total expenditure. When the price increases the total expenditure also increases and when the price decreases the total expenditure also decreases.

Point Method

In the point methrod. the price elasticity can be measured at the different point of linear & non-linear demand curve. It is also known as geometrical method. Elasticity at any point is the ratio of lower segment of straight line to the upper segment.
Mathematically,

Ep=\(\frac{Lower\:Segmant}{ Upper\: Segmant }\)

    A linear demand curve AB is given & it is required to measure elasticity at point C on linear demand curve; i.e.

The straight line demand curve AB is given & it is required to measure elasticity at point C on the demand curve. In given figure, corresponding to point C on the demand curve AB, price is OP1 & quantity demand is OQ2, quantity demanded rises from OQ1 to OQ2.


                                  We can get following conclusions from the above figure:

  1. Price elasticity of demand at point C is always equal to one (Ep = 1)
  2. Price elasticity of demand lying between C & A is less than one (Ep < 1)
  3. Price elasticity of demand at point A is equal to zero (Ep = 0)
  4. Price elasticity of demand at points lying between C & B is greater than one (Ep > 1)
  5. Price elasticity of demand at point A is equals to infinitive (Ep = ∞)

 

 

 

DETERMINANTS OF PRICE ELASTICITY OF DEMAND

Some goods are highly elastic or highly inelastic & some are less elastic or less inelastic. Those factor due to which price elasticity of demand is affected are called factor of price elasticity of demand. The elasticity of demand is determined by several factors which are briefly explained below:

  1. Availability of Substitute Goods :

The elasticity of demand depends upon availability of substitute goods. If the goods has many close substitute goods, demand becomes less elastic. For example, apple is high elastic than salt, because apple can be substituted to orange or banana or grapes as friuits but sait has no substitutes.

  1. Nature of commodity:

The elasticity of demand depends on the nature of a commodity.Demand for necessary goods such as salt, rice, kerosene, etc are inelastic because change in price of goods affects very less in the qualiity demanded for the goods.

Demand for luxuries goods like a sofa, car, television, etc are supposed to be highly elastic. Small change in their price results greater change in quantity demanded because there are use for comfort of life & people can live without them.

 

  1. Goods of Multiple Uses :

Demand for electricity is high elasticity because of its multiple purposes. If the price of electricity falls, consumers may use it for multiple purposes like cooking, washing clothes, pressing cloths etc in this situatiion the demand for electricity increase by high proportion.

  1. Level of Income :

Elasticity of demand also depends upon the level of income of the consumers, who have various soruce of income(rich) do not respond to small change in price of goods & services. Hence, demand for goods is inelastic.
          Those consumers who are poor, keenly respond towards small change in price of goods & services. So, the demand for such goods is elastic.

  1. Habitual Necessities :

Some goods such as wine cigarette & drugs are known as habitual necessities. Consumer's who are habitual to those goods doesn't respond to the small change in their price. Quantity demanded for such goods remains inelastic to any rise or fall in price level.

 

 

(Karna, Khanal, and Chaulagain)(Khanal, Khatiwada, and Thapa)(Jha, Bhusal, and Bista)

Bibliography

Jha, P.K., et al. Economics II. Kalimati, Kathmandu: Dreamland Publication, 2011.

Karna, Dr.Surendra Labh, Bhawani Prasad Khanal and Neelam Prasad Chaulagain. Economics. Kathmandu: Jupiter Publisher and Distributors Pvt. Ltd, 2070.

Khanal, Dr. Rajesh Keshar, et al. Economics II. Kathmandu: Januka Publication Pvt. Ltd., 2013.

 

 

 

Under total outlay method price elasticity of demand are separated in the three parts:

  1. Elasticity of Demand Greater than Unitary (Ep>1)
  2. Elasticity of Demand Equal to Unitary (Ep=1)
  3. Elasticity of Demand Less then Unitary (Ep<1)

Determinants of Price Elasticity of Demand

  1. Availability of Close Substitution Goods
  2. Luxuries Goods.
  3. Necessities Goods
  4. Consumers Habit
  5. Range of alternative uses of commodity

 

 

 

 

 

 

 

 

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