PRICE ELASTICITY OF DEMAND

The law of demand states that when the price of a good falls, consumers
demand more units of the good. But how much more? It is important and
useful to have magnitude of change in quantity demanded to a change
in price. It is called price elasticity of demand.
Price elasticity of demand measures the responsiveness of demand
of a good to a change in its price. Alfred Marshall was the first
economist to formulate the concept of price elasticity of demand as the
ratio of a relative change in quantity demanded to a relative change in
price. A relative measure is needed so that changes in different
measures can be compared. Numerically, price elasticity of demand eD, is
calculated as:
eD  – percentage change in quantity demanded
percentage change in price
change in quantity demanded
original quantity demanded
eD  –
change in price
original price
Q
 – (Q1  Q) / Q   Q   Q . P
(P1  P ) / P P
P Q P
where,
Q  Change in quantity demanded (or Q1 – Q)
Q  Original quantity demanded
P  Change in price (or P1 – P)
P  Original price
eD  Coefficient of elasticity of demand. eD is negative. The ratio is a negative
number because price and quantity demanded are inversely related.
In numerical sums, the minus sign is dropped from the numbers and all
percentage changes are treated
as positive.

FACTORS AFFECTING PRICE ELASTICITY OF DEMAND

The factors which determine the price elasticity of demand for a commodity or service
are:
1. Availability of Close Substitute. A good having close substitutes will have an
elastic demand and a good with no close substitutes will have an inelastic demand.
Example: commodities such as pen, cold drink, car, etc. have close substitutes. When
the price of these goods rise, the price of their substitutes remaining constant, there
is proportionately greater fall in the quantity demanded of these goods. That is,
their demand is elastic. Commodities such as prescribed medicines and salt have
no close substitutes and hence, have an inelastic demand.
2. Income of the Consumers. If the income level of consumers is high, the elasticity of
demand is less. It is because change in the price will not affect the quantity
demanded by a greater proportion. But in low income groups, the elasticity of
demand is high.
3. Luxuries versus Necessities. The price elasticity of demand is likely to be low for
necessities and high for luxuries. A necessity is a good or service that the consumer
must have such as food (bread, milk) and medicines. Luxuries are goods that are
enjoyable but not essential. Example: eating in a 5-Star hotel. If the price of
necessities rise, then demand will not fall by a greater proportion because their
purchase cannot be delayed. That is why, the price elasticity of demand in case of
necessity is low.
4. Proportion of Total Expenditure Spent on the Product. Higher the cost of the
good relative to total income of the consumer, more will be the price elasticity of
demand. If the price of bread, ink, salt, match box, etc., which is relatively low,
doubles it would have almost no effect on the quantity demanded of them. On the
other hand, if price of car doubles then the quantity demanded will fall by a
greater proportion showing high price elasticity of demand.
5. Number of Uses of the Commodity. The more the number of uses a commodity can
be put to, the more elastic is the demand. If a commodity has few uses, it has an
inelastic demand. Examples: goods like milk, eggs and electricity can be put to
many different uses and hence, enjoy elastic demand, i.e., when prices are low,
demand increases by a greater proportion as the goods can now be put to less
important uses also.
Elasticity of Demand
6. Time Period. If the time period needed to find substitutes of the commodity is more,
the price elasticity of demand is more and vice versa. Example: flying by aeroplane
has inelastic demand as no substitutes are available in the short run.
Before deciding whether the demand for a commodity is elastic or inelastic, all
the factors mentioned above must be simultaneously considered. A summary of
the factors affecting elasticity of demand is given in Table 4.1.
Determinants of Price Elasticity of Demand
Factors Elasticity of demand is more when....
1. Availability of substitutes. 1. More substitutes are available.
2. Income of the consumers. 2. The income of the consumer is less.
3. Luxuries versus necessities. 3. High priced luxuries are available.
4. Proportion of total 4. The proportion of total expenditure
expenditurespent on the spent is more.
product. 5. The number of uses of the good are
5. Number of uses of the more.
purchased commodity. 6. The time period required to find
6. Time period. substi- tutes is more.

4.1 MEASUREMENT OF PRICE ELASTICITY OF DEMAND BY

PERCENTAGEMETHOD
Percentage method is also called proportionate method. According to this method,
eD iscalculated by the following formula:
eD 
 Q  P
or e

D P Q
The absolute value of the coefficient of elasticity of demand ranges from zero to
infinity (0  eD  ). The five different magnitudes of elasticity of demand are
shown in Table 4.2.
Table 4.2 Different Values of Elasticity of Demand

Coefficient Type of Type Shape of

Description
Type of eD eD of Demand Curve
Good (See Fig 4.2)
1. eD  0 Perfectly This occurs when to Essentials Vertical (dF)
inelasti a percentage change in like life
c price there is no change saving
deman inquantity demanded. drugs
d
2. 0  eD  1 Inelastic This occurs when to Necessities Vertical (dF)
a percentage change in like food,
price there is less than fuel
proportionate change in
quantity demanded.
4.4 Saraswati Introductory

3. eD  1 Unitary This occurs when to a Normal Steeper

elastic percentage change in goods (dD)
demand price there is equal
change in quantity
demanded.
4. 1  eD   Elastic This occurs when to a Luxuries Linear demand
demand percentage change in like eating curve forms 45°
price there is greater in a 5-star angle with both the
change in quantity hotel axes (dC) or a
demanded. rectangular
hyperbola.
Flatter (dB)
5. eD   Perfectly This occurs when there Imaginary Horizontal
elastic is infinite change in situation (It (dA)
demand quantity demanded exist under
without any change in perfect
price. competition
)
Graphically, the five coefficients of price elasticity of demand are shown in
Fig. 4.1. The details of each co efficient of price elasticity of demand is as
follows:
1. Perfectly inelastic demand (eD  0)
When the demand of a commodity does
not change as a result of change in its
price, the demand is said to be perfectly
inelastic. The perfectly inelastic demand curve
is a vertical line parallel to y-axis as shown in Fig.
4.2. As it is clear from the diagram, price may be
OP or OP1 or OP2, but the demand
will be constant at OQ. In other words, there is Fig. 4.1 Different Types of Price
no Elasticityof Demand
effect of changes in the price on the quantity
demanded. It exists in case of essentials like F
life saving drugs. P2
Price

Table 4.3 Perfectly Inelastic Demand Schedule P

Price Demand
(`) (Units)
15 10 P1
10 10 d
O Q Quantity
20 10
Fig. 4.2 Perfectly Inelastic Demand
Curve

2. Inelastic (or less than unit elastic) Demand (0  eD  1)

When a change in price leads to a less than proportionate change in the demand,
the
demand is said to be less elastic or inelastic.
It is shown in Table 4.4, where price falls by ` 8, quantity demanded increases by
only 1 unit. The coefficient of price elasticity of demand is said to be less than 1 unit.
The slope of an inelastic demand curve is more, i.e., the demand curve is steep as
shown in Fig. 4.3.
It exists in case of necessities like food, fuel, etc.
Elasticity of Demand
Table 4.4 Inelastic Demand Schedule d
P
Price Demand

Price
(`) (Units)
10 20 P1
2 21 Q Q1 Quantity
D
The inelastic demand curve shows that change in
quantity
(PP ). demanded (QQ1) is less than change in price O
1 Fig. 4.3 Inelastic Demand
3. Unit Elastic Demand (eD  1) Curve

When percentage change in demand is d

equal to the percentage change in price, the 45°
demand for the commodity is said to be

Price
P
unitary elastic.
P1
It is shown in Table 4.5, where when price falls by ` 45° C
5, demand increases by 10 units. The unitary elastic O Q Q1 Quantity
demand curve is a straight downward sloping line Fig. 4.4 Unitary Elastic
forming 45° angles with both the axis. It is also a DemandCurve
rectangular hyperbola. It is drawn in Fig. 4.4. It
exists in case of normal goods.
Table 4.5 Unitary Elastic Demand Schedule
Price Demand (Units)
(`)
10 20
5 30
The unitary elastic demand curve shows that when price falls from OP to OP1,
demandrises from OQ to OQ1. The change in demand (QQ1) is equal to the
change in price (PP1).

4. Elastic (or more than unit elastic) Demand (1  eD  )

When a change in price leads to a more than d
proportionate change in demand, the demand is said P
Price

to be elastic or more than unit elastic. It is shown in P1

B
Table 4.6, when price falls by ` 1 demand increases
by 20 units. The coefficient of elasticity of demand is
Q Q1 Quantity
greater than unity. The demand curve is downward O
sloping and flatter as shown
in Fig. 4.5. It exists incase of
luxuries.
Fig. 4.5 Elastic Demand Curve

Table 4.6 Elastic Demand Schedule

Price (`) Demand
(Units)
10 20
9 40

The elastic demand curve shows that when price falls from OP to OP1, demand rises from
OQ to OQ1. The change in demand (QQ1) is more than the change in price (PP1).
5. Perfectly Elastic Demand (eD )
When the demand for a commodity rises or falls to
any extent without any change in price, the P
d A

Price
demand for the commodity is said to be perfectly
elastic. where quantity demanded keeps on
changing at the same price of `10. The O Q2 Q Q1 Quantity
coefficient of price elasticity of demand is
infinity. It is shown
graphically in. It exists under perfect Perfectly Elastic Demand Curve
competition, which is an ideal and imaginary
situation.
Table 4.7 Perfectly Elastic Demand Schedule
Price (`) Demand (Units)
10 10
10 5
10 20
Perfectly elastic demand curve is a horizontal line parallel to the x-axis. It means
that at price OP, quantity demanded can be OQ or OQ1 or OQ2.