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 is meant by the price elasticity of demand?
Price elasticity of demand (PED) is an economic measure that shows how the quantity demanded of a good or service changes in response to a change in its price. It calculates the percentage change in quantity demanded that occurs due to a one percent change in the price, helping to understand consumer sensitivity to price fluctuations.
2. What are the main methods for measuring the price elasticity of demand as per the CBSE syllabus?
According to the CBSE curriculum for the 2025-26 session, there are three primary methods to measure the price elasticity of demand:
- Percentage Method: This is the most common approach, calculating elasticity by dividing the percentage change in quantity demanded by the percentage change in price.
- Total Outlay or Total Expenditure Method: This method assesses elasticity by comparing the total expenditure on a commodity before and after its price changes.
- Geometric or Point Method: This method is used to determine elasticity at a specific point on a linear or non-linear demand curve.
3. What are the different types or degrees of price elasticity of demand?
The degrees of price elasticity describe the level of responsiveness of demand to price changes:
- Perfectly Elastic Demand (ED = ∞): An infinitesimal change in price leads to an infinitely large change in quantity demanded.
- Perfectly Inelastic Demand (ED = 0): A change in price causes no change in the quantity demanded.
- Unitary Elastic Demand (ED = 1): The percentage change in quantity demanded is exactly equal to the percentage change in price.
- Relatively Elastic Demand (ED > 1): The percentage change in quantity demanded is greater than the percentage change in price.
- Relatively Inelastic Demand (ED < 1): The percentage change in quantity demanded is less than the percentage change in price.
4. Why is the price elasticity of demand coefficient typically a negative value?
The price elasticity of demand is generally negative due to the fundamental law of demand, which establishes an inverse relationship between price and quantity demanded. When the price of a product rises, its quantity demanded falls, and vice versa. Since these two variables move in opposite directions, the resulting calculation is a negative number. However, for ease of comparison, economists often refer to its absolute (positive) value.
5. How does the price elasticity of demand affect a firm’s total revenue?
Price elasticity is a critical factor for a firm's pricing strategy because it determines how total revenue (Price × Quantity) will change:
- If demand is elastic (ED > 1), lowering the price will increase total revenue because the increase in quantity sold is proportionally larger than the price drop.
- If demand is inelastic (ED < 1), raising the price will increase total revenue because the decrease in quantity sold is proportionally smaller than the price rise.
- If demand is unitary elastic (ED = 1), any change in price will be perfectly offset by a change in quantity, leaving total revenue unchanged.
6. What are the most important factors or determinants that affect the price elasticity of demand?
Several factors influence how elastic or inelastic the demand for a good is:
- Availability of Substitutes: Goods with many close substitutes tend to have more elastic demand.
- Nature of the Commodity: Necessities like food and medicine typically have inelastic demand, while luxuries have elastic demand.
- Proportion of Income Spent: Items that constitute a small fraction of a consumer's income usually have inelastic demand.
- Time Period: Demand often becomes more elastic over a longer period as consumers have more time to find alternatives.
- Number of Uses: A commodity with several alternative uses, like electricity, tends to have more elastic demand.
7. Why is the concept of price elasticity of demand crucial for government finance and taxation policies?
The concept of price elasticity is vital for government fiscal policy, especially for determining which goods to tax. Governments typically impose higher indirect taxes on goods with inelastic demand (e.g., fuel, tobacco). Since a price increase from the tax does not significantly reduce the quantity demanded for such goods, the government can secure a stable and substantial tax revenue stream. Conversely, taxing goods with elastic demand would be less effective, as it would cause a large drop in consumption and lower-than-expected tax receipts.
8. What is the practical difference between using point elasticity and arc elasticity to measure demand responsiveness?
Both point and arc elasticity measure responsiveness on a demand curve, but they are applied in different situations:
- Point Elasticity is used to calculate elasticity at a single, precise point on the demand curve. It is most accurate for measuring the effect of an infinitesimally small price change.
- Arc Elasticity is used to calculate the average elasticity over a range or segment between two distinct points on the demand curve. It provides a more accurate measure when dealing with larger, more significant price changes.
