Price elasticity of Demand

Elasticity of Demand

The quantity demanded varies inversely with price, according to the law of demand. The law of demand demonstrates how the quantity demanded will change in relation to changes in the factors that influence demand, including price, goods with a similar price, consumer income, consumer taste, preference, and fashion, customs, advertising spending, population size, weather, the availability of money, expectations regarding price changes, tax rates, etc. However, this law does not specify what proportionate or percentage change in the demand determinants causes what proportionate or percentage change in the quantity sought. Elasticity of demand was thus developed to quantify the proportionate or percentage variation in the quantity sought together with its drivers.

Elasticity of demand is a metric used to assess how closely demand drivers and quantity demanded are related. The ratio of the percentage change in the amount demanded to the percentage change in its determinant of demand is generally known as the elasticity of demand.

Mathematically,

Ed = %change in quantity demanded/ % change in any one quantitative determinant of demand

Price Elasticity of Demand

The relationship between the proportionate or percentage change in quantity demanded and the proportionate or percentage change in price is known as price elasticity. In other words, price elasticity of demand is equal to the ratio of the change in quantity required divided by the change in price, expressed as a percentage or proportion.

The degree to which the quantity required for a given good responds to changes in price is measured by the price elasticity of demand. In other words, the ratio of the percentage change in the quantity demanded to the percentage change in price is the definition of price elasticity of demand. The following is how it can be mathematically expressed:

Price elasticity of demand (ep) = Percentage change in quantity of demand / Percentage change in price

Where, ep = Coefficient of price elasticity of demand.

The price elasticity of demand is always negative since there is an inverse or negative relationship between the price and the amount required. However, we disregard the negative sign and only consider the numerical value of price elasticity of demand in order to make comprehending the magnitude of reaction of quantity demanded to the change in price more straightforward.

Numerical example:

Rice now costs Rs. 50 per kg, up from Rs. 40 per kg. The price increase for rice causes a drop in demand from 500kg to 450kg. Find the rice demand's price elasticity.

Here,

Initial quantity demand (Q) = 500kg

Final quantity demand =450kg

Change in quantity demand (∆Q)= 450-500= -50kg

Initial Price (P) = Rs.40

Final price = Rs.50

Change in price (∆P) = 50-40= Rs.10

Ep =( ∆Q/∆P)×(P/Q)

= (-50/500)×(40/10)

= -0.4

Types of Price Elasticity of Demand

Price elasticity of demand is essentially divided into five categories. These are what they are:

1. Perfectly Inelastic Demand (ep = 0): It is said to be a perfectly inelastic demand if there is no change in the quantity sought as a result of the price change. Simply put, demand is said to be perfectly inelastic when it remains the same for a good notwithstanding a change in price. It can be appropriate for products with very low prices. For instance, the quantity of rice demanded in the community remains constant at 1000 kg whether the price drops from Rs. 18 to Rs. 16 or rises from Rs. 18 to 20.
2. Relatively Inelastic Demand (ep < 1): It is said to be a relatively inelastic demand when the percentage or proportionate change in the amount required of a specific commodity is less than the percentage or proportionate change in the price. For instance: The quantity demanded rises from 800 kg to 890 kg as a result of the decrease in maize's price from Rs. 50 to Rs. 40 per kg. Mango demand is down 10% this year as a result of this year's 20% price rise over last year. It is connected to the items used for daily consumption.
3. Unitary Elastic Demand (ep = 1): Demand for a good is said to be unitary elastic when the percentage or proportionate change in the amount demanded is equal to the percentage or proportionate change in price. For instance: The quantity requested rises from 200 units to 300 units as a result of a decrease in pricing for Good A from Rs. 100 to Rs. 50 per unit. When the price of X goods rises by 10%, demand for those goods declines by 10%.
4. Relatively Elastic Demand (ep > 1): Demand for a commodity is said to be relatively elastic when the percentage or proportionate change in quantity sought is equal to or larger than the percentage or proportionate change in price. It has to do with expensive products. For instance: The quantity requested rises from 300 units to 600 units as a result of the TV's price dropping from Rs. 10000 to Rs. 8000 each unit. The number of students attending ABC school will decline by 20% if the admissions fees are increased by 10%.
5. Perfectly Elastic Demand (ep = ∞): Demand for a commodity is said to be fully elastic if a minor change in price (i.e., decrease or rise) results in infinite demand or zero demand. If a little change in price would result in an infinite change in the quantity sought, the demand for that commodity is said to be fully elastic. No change in price, observably, results in an endless change in demand. It is an excellent hypothetical idea. For instance: If the price of y goods drops from Rs. 100 to Rs. 99, the quantity requested increases to infinity from 200 units.

Determinants of Price Elasticity of Demand

Following are the main factors that affect a commodity's price elasticity of demand in relation to its own price:

• The availability of alternatives; if there are close alternatives, the demand for a commodity is more elastic.
• Demand is more elastic over the long term than it is in the short term.
• The type of need that the good or service fills. Luxury items typically have a lower price elasticity than daily requirements or goods for consumption.
• A commodity's elasticity of demand will often increase with the amount of revenue spent on it, and vice versa.
• A commodity's price elasticity will increase in proportion to the number of different applications it may have, and vice versa.

Reference

Koutosoyianis, A (1979), Modern Microeconomics, London Macmillan