Understanding Price Elasticity of Demand in Economics

Dr Kaneez Fatima Asstt: Professor Economics GDC Boys Anantnag

Price Elasticity of Demand The determinants of demand for a commodity from an individual s point of view are : 1 Price of the commodity 2 Prices of related goods 3 Income of the consumer 4 Taste of the consumer 5 Consumer s expectations about the future. Symbolically Dn=f(Pn; P1,P2--------Pn-1; Y; T; E) This is the demand function ,which shows that the demand for commodity n depends upon the price of that commodity Pn; the prices of various related goods P1,P2-----Pn-1; income of the consumer Y; tastes of the consumer T and consumers expectations about the future E.

So for as the price elasticity of demand is concerned it indicates the degree of responsiveness of quantity demanded of a good to the change in its price, all other factors mentioned above are held constant. Precisely price elasticity of demand is defined as the ratio of the percentage change in quantity demanded of a commodity to a percentage change in price i.e a ratio between a cause and an effect in percentage terms. The cause goes in the bottom half or denominator of the ratio, while the upper half or numerator. Thus Price elasticity of demand (Ed)= percentage chnge in quantity demanded percentage change in price effect goes in the

For example ,suppose 5% rise in price of sugar causes its quantity demanded to fall by 10%, we calculate price elasticity of demand for sugar as Ed= 10/5 =2 Since as price rises , quantity demanded falls, so we should put negative sign before 10 and positive sign before 5 that is we obtain the value of price elasticity as: Ed= -10/+5 = -2 It shows that the change in price and change in quantity demanded are inversely related to each other .However, for the sake of convenience, the minus sign is often omitted ,as we have to measure the magnitude of responsiveness of quantity demanded of a good to a change in its price. Therefore it is best to deal with absolute values only and to omit the minus sign. In symbols price elasticity of demand Ed= q x100/q p x100/p or Ed= q/q p/p or Ed= q/ p x p/q

Where Ed is price elasticity of demand. p = Initial price. q = quantity demanded at initial price. p =change in price. q =change in quantity demanded. Since as common observation goods show great variation in respect of elasticity of demand i.e their responsiveness to change in price.The demand for some goods is more responsive to the changes in price than those for others or we can say that demand for some goods is more elastic than those for the others. Therefore we must take in to account the degree of price elasticity of demand.

Degree of Price Elasticity Of Demand In terms of degree ,price elasticity of demand categories. 1 Perfectly elastic demand 2 Perfectly inelastic demand 3 Unitary elastic demand 4 Elastic demand 5 Inelastic demand 1.Perfectly elastic demand:-In case of perfectly elastic demand ,the unnoticeable change in price would cause the buyers to change the quantity demanded to a great (unnoticeable) rise in price of product will cause the buyers completely away from the product so that the quantity demanded falls to zero and vice versa. is classified into five extent. In other words a small to switch

The demand curve representing perfectly elastic demand is parallel to x-axis as shown in figure1, and the elasticity is equal to infinity (Ed = ). Y price P1 P2 P3 P D Figure. 1 O Q1 Q2 Q3 X Quantity. (Ed= )

Here one would observe that the small change in price would cause the quantity demanded to change from OQ1 to OQ2 or even to OQ3 and so on. 2. Perfectly inelastic demand :- In this case change in price of a commodity does not affect the quantity demanded of the commodity at all. This implies a situation where demand is totally unresponsive to changes in the price of the commodity. Thus the elasticity of demand is zero(Ed =0).The demand curve representing perfectly inelastic demand is parallel to y-axis ,as shown in figure 2.It is clear from the figure 2 , that the demand for the commodity remains the same (OQ) whatever the price

Y D Figure. 2 (Ed=0) p3 price p2 p1 O Q X quantity

3.Unitary elastic demand :- In this case percentage changes in price and quantity demanded are precisely the same i.e. if a 10% increase in price is accompanied by a 10% decrease in demand, the price elasticity of demand is unitary or (Ed =1) The figure 3 indicates the unitary elastic demand where PP1 =QQ1 Y D Figure. 3 (Ed=1) P P1 Price D o X Q Q1 Quantity

4. Elastic demand :- In certain cases the responsiveness of demand measured in terms of percentage change is for greater than the percentage change in the price of the commodity.i.e if the price of the commodity rises by 10%,then in response to it the demand falls by a higher percentage. This is known as elastic demand and in this case price elasticity of demand will be greater than 1 but less than infinity (1< Ed < infinity).Generally the demand for luxury goods is elastic .Consider the fig.4, a given rise in price from OP to OP1, causes the quantity demand to decrease in greater proportion i.e. PP1 < QQ1.

Y D Figure .4 ( 1<Ed ) P1 P price D O Q Q1 Quantity. X

5. Inelastic demand:- When a given percentage change in price of a commodity leads to a smaller percentage change in quantity demanded, it will be the case of inelastic demand .Here elasticity will be less than unity but greater than zero (0 < Ed < 1). Demand for necessary goods display such elasticity. Fig. 5 indicates the inelastic demand ,where the change in price PP1 is greater than the change in quantity demanded, QQ1. Y D Price Figure .5 (0< Ed <1) P1 P D O Q1 Q Quantity X

In fact there are many reasons but the main reason for differences in elasticity of demand is the possibility of substitution i.e. the presence or absence of competing substitutes. The greater the ease with which substitutes can be found for a commodity, the greater will be the price elasticity of demand of that commodity and vice versa.