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- 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}}]