Price Elasticity of Demand (PED) - Copy
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Price Elasticity of Demand (Ep)
Price elasticity of demand (Ep) measures the
responsiveness of demand after a change in
price.
Ep =
% change in Q.D
% change in Price
Suppose the percentage decrease in the price
of the commodity is 25% and the percentage
increase in the quantity demanded is 50%.
Hence,
ep = 50%/-25% = -2
Price Elasticity of
Demand
• The price elasticity of demand can be
any value between zero and infinity.
• The price elasticity of demand reflects
the law of demand relation between
price and quantity. An elastic demand
means that the quantity demanded is
relatively responsive to changes in
price. An inelastic demand means that
the quantity demanded is not very
responsive to changes in price.
Degrees of Price Elasticity of Demand
Degrees of Price Elasticity of Demand
1. Perfectly Elastic:
Perfectly elastic given by
E = ∞. Shape of demand
curve is horizontal. It
means
that
at
a
particular price, buyers
are ready to buy all
commodities. If there is
even a slight change in
the price, the quantity
demanded will be zero.
(Perfect Competitive
Market)
Degrees of Price Elasticity of Demand
2. Perfectly Inelastic: Another type
shown in this chart is perfectly
inelastic, given by E = 0. Perfectly
inelastic means that quantity
demanded is unaffected by any
change in price. The quantity is
essentially fixed. It does not matter
how much price changes, quantity
does not Change. Looking at
Medicine, for instance, it is
possible that, following a 5%
increase in its price, the demand
for the product remains unchanged
because the good is such a
necessity.
Degrees of Price Elasticity of Demand
3. Unit Elastic: The third
category is unit elastic, in
which
the
coefficient
of
elasticity is E = 1. In this case,
any change in price is
matched by an equal relative
change
in
quantity.
The
percentage change in quantity
is equal to the percentage
change in price. For example,
a 10 percent change in price
induces a equal 10 percent
change in quantity demanded.
Degrees of Price Elasticity of Demand
• Unit Elastic is primarily a dividing line, a boundary,
between elastic and inelastic. If the coefficient of
elasticity is greater than one, then a good is elastic. If
the coefficient of elasticity is less than one, then a good
is inelastic. If the coefficient just happens to be exactly
equal to one, then it is unit elastic.
• For example, a theater may be able to sell 100 tickets
at $20 each and only 80 tickets at $25 each, but at
either price/demand combination the total revenue is
$2000. In most cases, perfect unitary elasticity does not
occur.
Degrees of Price Elasticity of Demand
4. Relatively Inelastic: The fourth
category is relatively inelastic, in
which the coefficient of elasticity
falls in the range 0 < E < 1. With
relatively
inelastic
demand,
relatively large changes in price
cause relatively small changes in
quantity. The percentage change
in quantity is less than the
percentage change in price. In
this case, a 10 percent change in
price induces less than a 10
percent change in quantity
demanded (perhaps only 5
percent). Shape of demand curve
is quite steep. [Necessaries]
Degrees of Price Elasticity of Demand
5. Relatively Elastic: The
second category is relatively
elastic,
in
which
the
coefficient of elasticity falls in
the range 1 < E < ∞. With
relatively
elastic
demand,
relatively small changes in
price cause relatively large
changes in quantity. Quantity
is very responsive to price.
The percentage change in
quantity is greater than the
percentage change in price.
Here a 10 percent change in
price leads to more than a 10
Measurement of Price Elasticity of
Demand
1. Total Outlay Method
• Total outlay or expenditure (P * Q) by
consumers are the revenue earned by the
sellers.
• When price of a good changes, it brings about
a change in the total revenue of the seller. The
change in total revenue depends upon the
price elasticity of demand. When price of a
good changes, three situations can take place.
1. Total Outlay Method
Under this method, Alfred Marshall suggested
three types of elasticity:
1. Elasticity of demand greater than one:
•. If the expenditure made by the consumer is
increases due to the fall of price of commodity,
then it is known as elasticity of demand greater
than one. It is a case of elastic demand.
•. Normal Goods : Essential & Luxurious
1. Total Outlay Method
2. Elasticity of demand less than
one
• If the total expenditure made by
consumer decreases due to fall in
price is known as elasticity of
demand less than one. It is a case of
inelastic demand
• Inferior Goods
1. Total Outlay Method
3. Elasticity of demand equal to one
• If the total expenditure made by
consumers remains constant due to any
change in price of any commodity is
called elasticity of demand equal to
one.
• It is difficult to give example in this
situation
1. Total Outlay Method
1. Total Outlay Method
1. Total Outlay Method
2. Percentage Method
Perfectly inelastic demand (ep = 0)
Perfectly elastic demand (ep = ∞)
Unitary elasticity (ep = 1)
Relatively Elastic Demand (ep > 1)
Relativley Inelastic (less elastic) demand (ep < 1)
3. Arc Elasticity of Demand
• Price elasticity of demand is the percentage
change in quantity demanded for a unit
change in price. Arc elasticity computes the
percentage change between two points in
relation to the average of the two prices and
the average of the two quantities, rather
than the change from one point to the next.
This provides the average elasticity for the
arc of the curve between the two points.
Hence, the term "arc elasticity."
3. Arc Elasticity of Demand
• Arc elasticity of demand is a measure of
the average responsiveness to price
change exhibited by a demand curve over
some finite stretch of the curve.
• Arc elasticity is the elasticity at the midpoint of an arc of a demand curve.
3. Arc Elasticity of Demand
• In the case of arc elasticity we have to
measure the price elasticity over an
arc of the demand curve such as
between points A and B on the
demand curve DD in the above figure.
In the measurement of arc elasticity
we use the averages of the two prices
and two quantities (both original and
subsequent). Thus the formula for
measuring arc elasticity of demand is:
3. Arc Elasticity of Demand
3. Arc Elasticity of Demand
Importance of Price Elasticity of Demand
• 1. International Trade: In order to fix price of the
goods to be exported it is important to its
knowledge about the elasticity of demand for
such goods.
• 2. Formulation of government policy: The
concept of price elasticity of demand is
important for formulating govt. policy specially
the taxation policy.
A country may fix higher prices for the products
with inelastic of demand or Govt. can impose
higher taxes on goods in elastic of demand.
Importance of Price Elasticity of
Demand
3. Factor Pricing: Price elastic of demand
helps in determining price to be paid to the
factors of production.
4. Decision Monopolist: A monopolist
considers the nature of demand while fixing
price of his product. If demand for the
product is elastic then he will fix low price.
Income Elasticity of Demand
• Income Elasticity measures the
responsiveness of demand due to an
increase or decrease in consumer
income.
• Ey = % change in quantity
demanded
% change in income
Types of Income Elasticity
• High income elasticity of demand (Ey >1): An
increase in income is accompanied by a
proportionally
larger
increase
in
quantity
demanded. This is typical of a luxury or superior
good.
• Unitary income elasticity of demand (Ey =1): An
increase in income is accompanied by a
proportional increase in quantity demanded.
• Low income elasticity of demand (Ey <1): An
increase in income is accompanied by less than a
proportional increase in quantity demanded. This is
characteristic of a necessary good.
Types of Income Elasticity
• Zero income elasticity of demand (Ey =0):
A change in income has no effect on the
quantity bought.
• Negative income elasticity of demand (Ey
<0):
An
increase
in
income
is
accompanied by a decrease in the
quantity demanded. This is an inferior
good. The consumer may be selecting
more luxurious as a result of the increase
in income.
Income Elasticity of Demand
Percentage Method
• ey = (ΔX/X) / (ΔY/Y) = (ΔX/ΔY) × (Y/X)
where,
• X = Quantity demanded for a
Commodity X
• Y = income of the consumer
Percentage Method
• Suppose a consumer’s demand for a commodity
increases from 10 units per week to 20 units per
week when his income rises from $200 to $300.
• ey = ?
• The numerical value of income elasticity of demand
may be positive or negative. A positive value implies
that an increase in income is associated with an
increase in the quantity of goods purchased. For
instance, normal goods always have a positive
income elasticity of demand.
Arc Method
• Say that you own a company that supplies vending
machines. Currently, your vending machines sell soft
drinks at $1.50 per bottle, and at that price, customers
purchase 2,000 bottles per week. For your community,
the weekly income is $600.
• Then a major employer in the community closes, and a
number of workers lose their job. The average weekly
income in the community falls to $400 and you note
that your vending machine sales decrease to 500. You
didn’t change the price of soft drinks, but your sales
decreased dramatically due to the change in income.
Arc Method
• So the income elasticity of demand
for soft drinks equals
• The income elasticity value tells you a
1 percent increase in income causes
a 3 percent increase in demand. Soft
drinks are a normal good.
Arc Method
Price elasticity of demand (Ep) measures the
responsiveness of demand after a change in
price.
Ep =
% change in Q.D
% change in Price
Suppose the percentage decrease in the price
of the commodity is 25% and the percentage
increase in the quantity demanded is 50%.
Hence,
ep = 50%/-25% = -2
Price Elasticity of
Demand
• The price elasticity of demand can be
any value between zero and infinity.
• The price elasticity of demand reflects
the law of demand relation between
price and quantity. An elastic demand
means that the quantity demanded is
relatively responsive to changes in
price. An inelastic demand means that
the quantity demanded is not very
responsive to changes in price.
Degrees of Price Elasticity of Demand
Degrees of Price Elasticity of Demand
1. Perfectly Elastic:
Perfectly elastic given by
E = ∞. Shape of demand
curve is horizontal. It
means
that
at
a
particular price, buyers
are ready to buy all
commodities. If there is
even a slight change in
the price, the quantity
demanded will be zero.
(Perfect Competitive
Market)
Degrees of Price Elasticity of Demand
2. Perfectly Inelastic: Another type
shown in this chart is perfectly
inelastic, given by E = 0. Perfectly
inelastic means that quantity
demanded is unaffected by any
change in price. The quantity is
essentially fixed. It does not matter
how much price changes, quantity
does not Change. Looking at
Medicine, for instance, it is
possible that, following a 5%
increase in its price, the demand
for the product remains unchanged
because the good is such a
necessity.
Degrees of Price Elasticity of Demand
3. Unit Elastic: The third
category is unit elastic, in
which
the
coefficient
of
elasticity is E = 1. In this case,
any change in price is
matched by an equal relative
change
in
quantity.
The
percentage change in quantity
is equal to the percentage
change in price. For example,
a 10 percent change in price
induces a equal 10 percent
change in quantity demanded.
Degrees of Price Elasticity of Demand
• Unit Elastic is primarily a dividing line, a boundary,
between elastic and inelastic. If the coefficient of
elasticity is greater than one, then a good is elastic. If
the coefficient of elasticity is less than one, then a good
is inelastic. If the coefficient just happens to be exactly
equal to one, then it is unit elastic.
• For example, a theater may be able to sell 100 tickets
at $20 each and only 80 tickets at $25 each, but at
either price/demand combination the total revenue is
$2000. In most cases, perfect unitary elasticity does not
occur.
Degrees of Price Elasticity of Demand
4. Relatively Inelastic: The fourth
category is relatively inelastic, in
which the coefficient of elasticity
falls in the range 0 < E < 1. With
relatively
inelastic
demand,
relatively large changes in price
cause relatively small changes in
quantity. The percentage change
in quantity is less than the
percentage change in price. In
this case, a 10 percent change in
price induces less than a 10
percent change in quantity
demanded (perhaps only 5
percent). Shape of demand curve
is quite steep. [Necessaries]
Degrees of Price Elasticity of Demand
5. Relatively Elastic: The
second category is relatively
elastic,
in
which
the
coefficient of elasticity falls in
the range 1 < E < ∞. With
relatively
elastic
demand,
relatively small changes in
price cause relatively large
changes in quantity. Quantity
is very responsive to price.
The percentage change in
quantity is greater than the
percentage change in price.
Here a 10 percent change in
price leads to more than a 10
Measurement of Price Elasticity of
Demand
1. Total Outlay Method
• Total outlay or expenditure (P * Q) by
consumers are the revenue earned by the
sellers.
• When price of a good changes, it brings about
a change in the total revenue of the seller. The
change in total revenue depends upon the
price elasticity of demand. When price of a
good changes, three situations can take place.
1. Total Outlay Method
Under this method, Alfred Marshall suggested
three types of elasticity:
1. Elasticity of demand greater than one:
•. If the expenditure made by the consumer is
increases due to the fall of price of commodity,
then it is known as elasticity of demand greater
than one. It is a case of elastic demand.
•. Normal Goods : Essential & Luxurious
1. Total Outlay Method
2. Elasticity of demand less than
one
• If the total expenditure made by
consumer decreases due to fall in
price is known as elasticity of
demand less than one. It is a case of
inelastic demand
• Inferior Goods
1. Total Outlay Method
3. Elasticity of demand equal to one
• If the total expenditure made by
consumers remains constant due to any
change in price of any commodity is
called elasticity of demand equal to
one.
• It is difficult to give example in this
situation
1. Total Outlay Method
1. Total Outlay Method
1. Total Outlay Method
2. Percentage Method
Perfectly inelastic demand (ep = 0)
Perfectly elastic demand (ep = ∞)
Unitary elasticity (ep = 1)
Relatively Elastic Demand (ep > 1)
Relativley Inelastic (less elastic) demand (ep < 1)
3. Arc Elasticity of Demand
• Price elasticity of demand is the percentage
change in quantity demanded for a unit
change in price. Arc elasticity computes the
percentage change between two points in
relation to the average of the two prices and
the average of the two quantities, rather
than the change from one point to the next.
This provides the average elasticity for the
arc of the curve between the two points.
Hence, the term "arc elasticity."
3. Arc Elasticity of Demand
• Arc elasticity of demand is a measure of
the average responsiveness to price
change exhibited by a demand curve over
some finite stretch of the curve.
• Arc elasticity is the elasticity at the midpoint of an arc of a demand curve.
3. Arc Elasticity of Demand
• In the case of arc elasticity we have to
measure the price elasticity over an
arc of the demand curve such as
between points A and B on the
demand curve DD in the above figure.
In the measurement of arc elasticity
we use the averages of the two prices
and two quantities (both original and
subsequent). Thus the formula for
measuring arc elasticity of demand is:
3. Arc Elasticity of Demand
3. Arc Elasticity of Demand
Importance of Price Elasticity of Demand
• 1. International Trade: In order to fix price of the
goods to be exported it is important to its
knowledge about the elasticity of demand for
such goods.
• 2. Formulation of government policy: The
concept of price elasticity of demand is
important for formulating govt. policy specially
the taxation policy.
A country may fix higher prices for the products
with inelastic of demand or Govt. can impose
higher taxes on goods in elastic of demand.
Importance of Price Elasticity of
Demand
3. Factor Pricing: Price elastic of demand
helps in determining price to be paid to the
factors of production.
4. Decision Monopolist: A monopolist
considers the nature of demand while fixing
price of his product. If demand for the
product is elastic then he will fix low price.
Income Elasticity of Demand
• Income Elasticity measures the
responsiveness of demand due to an
increase or decrease in consumer
income.
• Ey = % change in quantity
demanded
% change in income
Types of Income Elasticity
• High income elasticity of demand (Ey >1): An
increase in income is accompanied by a
proportionally
larger
increase
in
quantity
demanded. This is typical of a luxury or superior
good.
• Unitary income elasticity of demand (Ey =1): An
increase in income is accompanied by a
proportional increase in quantity demanded.
• Low income elasticity of demand (Ey <1): An
increase in income is accompanied by less than a
proportional increase in quantity demanded. This is
characteristic of a necessary good.
Types of Income Elasticity
• Zero income elasticity of demand (Ey =0):
A change in income has no effect on the
quantity bought.
• Negative income elasticity of demand (Ey
<0):
An
increase
in
income
is
accompanied by a decrease in the
quantity demanded. This is an inferior
good. The consumer may be selecting
more luxurious as a result of the increase
in income.
Income Elasticity of Demand
Percentage Method
• ey = (ΔX/X) / (ΔY/Y) = (ΔX/ΔY) × (Y/X)
where,
• X = Quantity demanded for a
Commodity X
• Y = income of the consumer
Percentage Method
• Suppose a consumer’s demand for a commodity
increases from 10 units per week to 20 units per
week when his income rises from $200 to $300.
• ey = ?
• The numerical value of income elasticity of demand
may be positive or negative. A positive value implies
that an increase in income is associated with an
increase in the quantity of goods purchased. For
instance, normal goods always have a positive
income elasticity of demand.
Arc Method
• Say that you own a company that supplies vending
machines. Currently, your vending machines sell soft
drinks at $1.50 per bottle, and at that price, customers
purchase 2,000 bottles per week. For your community,
the weekly income is $600.
• Then a major employer in the community closes, and a
number of workers lose their job. The average weekly
income in the community falls to $400 and you note
that your vending machine sales decrease to 500. You
didn’t change the price of soft drinks, but your sales
decreased dramatically due to the change in income.
Arc Method
• So the income elasticity of demand
for soft drinks equals
• The income elasticity value tells you a
1 percent increase in income causes
a 3 percent increase in demand. Soft
drinks are a normal good.
Arc Method
