Elasticity = responsiveness of consumer due to the price change of any commodity
Definitions
The law of demand tells us that consumers will respond to a price decrease by buying more of a product (other things remaining constant), but it does not tell us how much more.
The degree of responsiveness or sensitivity of consumers to a change in price is measured by the concept of price elasticity of demand
If a small change in price is accompanied by a large change in quantity demanded, the product is said to be elastic (or responsive to price changes). The opposite also applies; a product is inelastic if a large change in price is accompanied by a small amount of change in demand.
Business know that they face demand curves, but rarely do they know what these curves look like. Yet sometimes a business needs to have a good idea of what part of a demand curve looks like if it is to make good decisions. If Rick's Pizza raises its prices by ten percent, what will happen to its revenues? The answer depends on how consumers will respond. Will they cut back purchases a little or a lot? This question of how responsive consumers are to price changes involves the economic concept of elasticity.
DEGREES OF PRICE ELASTICITY
Different commodities have different price elasticities. Some commodities have more elastic demand while others have relative elastic demand. Basically, the price elasticity of demand ranges from zero to infinity. It can be equal to zero, less than one, greater than one and equal to unity.
According to Dr. Marshall : "The elasticity or responsiveness of demand in a market is great or small according as the amount demanded increases much or little for a given fall in price and diminishes much or little for a given rise in price."
However, some particular values of elasticity of demand have been explained as under ;
MEASUREMENT OF PRICE ELASTICITY OF DEMAND
There are five methods to measure the price elasticity of demand.
Total Expenditure Method
Dr. Marshall has evolved the total expenditure method to measure the price elasticity of demand. According to this method, elasticity of demand can be measured by considering the change in price and the subsequent change in the total quantity of goods purchased and the total amount of money spend on it.
Proportionate Method
This method is also associated with the name of Dr. Marshall. According to this method, "price elasticity of demand is the ratio of percentage change in the amount demanded to the percentage change in price of the commodity." It is also known as the Percentage Method, Flux Method, Ratio Method, and Arithmetic Method.
Ed = Proportionate change in Quantity Demanded
proportionate change in price
Arc Elasticity of Demand
Revenue Method
Mrs.; Joan Robinson has given this method. She says that elasticity of demand can be measured with the help of average revenue and marginal revenue. Therefore, a sale proceeds that a firm obtains by selling its products is called its revenue. However, when total revenue is divided by the number of units sold, we get average revenue. On the contrary, when addition is made to the total revenue by the sale of one more unit of the
commodity is called marginal revenue.
Formula:
Ed = A
A-M
where Ed represents elasticity of demand, A = average revenue and M = marginal revenue.
When the percentage change in quantity demanded is greater than the percentage change in price, the demand is said to be elastic.
In other words, relatively small changes in price cause relatively large changes in quantity.
Observe the graph, price of the goods increased from P1 to P2 and eventually the demand for the goods decreases from Q1 to Q2. But the proportionate change in price is less than the proportionate change in demand
Observe the graph, price of the goods increased from P1 to P2 and eventually the demand for the goods decreases from Q1 to Q2. The proportionate change in price is more than the proportionate change in demand.
Facts [+]
WASHINGTON: US motorists drove 1.2 per cent fewer miles in 2011, the lowest level measured since 2003, while concerns about the high cost of gasoline are rising, the government announced Tuesday.
According to Federal Highway Administration figures, last year US drivers drove 57.5 billion km less than they did in 2010.
Since 2008, the distance covered by US drivers, which is calculated by taking into account traffic volume on the highways, has fallen due to the economic crisis and the high price of gasoline.
Unit Elastic means that a change in price leads to a one-for-One change in quantity demanded. For example, a doubling of the price leads to a halving of the quantity demanded. Remember by unit, meaning single or one.
Definitions
- According to Alfred Marshall: "Elasticity of demand may be defined as the percentage change in quantity demanded to the percentage change in price."
- According to A.K. Cairncross : "The elasticity of demand for a commodity is the rate at which quantity bought changes as the price changes."
- According to J.M. Keynes : "The elasticity of demand is a measure of the relative change in quantity to a relative change in price."
- According to Kenneth Boulding : "Elasticity of demand measures the responsiveness of demand to changes in price."
The law of demand tells us that consumers will respond to a price decrease by buying more of a product (other things remaining constant), but it does not tell us how much more.
The degree of responsiveness or sensitivity of consumers to a change in price is measured by the concept of price elasticity of demand
If a small change in price is accompanied by a large change in quantity demanded, the product is said to be elastic (or responsive to price changes). The opposite also applies; a product is inelastic if a large change in price is accompanied by a small amount of change in demand.
Business know that they face demand curves, but rarely do they know what these curves look like. Yet sometimes a business needs to have a good idea of what part of a demand curve looks like if it is to make good decisions. If Rick's Pizza raises its prices by ten percent, what will happen to its revenues? The answer depends on how consumers will respond. Will they cut back purchases a little or a lot? This question of how responsive consumers are to price changes involves the economic concept of elasticity.
DEGREES OF PRICE ELASTICITY
Different commodities have different price elasticities. Some commodities have more elastic demand while others have relative elastic demand. Basically, the price elasticity of demand ranges from zero to infinity. It can be equal to zero, less than one, greater than one and equal to unity.
According to Dr. Marshall : "The elasticity or responsiveness of demand in a market is great or small according as the amount demanded increases much or little for a given fall in price and diminishes much or little for a given rise in price."
However, some particular values of elasticity of demand have been explained as under ;
Types of Price
Elasticity of Demand:-
- Perfectly elastic demand.
- Perfectly inelastic demand.
- Relatively elastic demand.
- Relatively inelastic demand.
- Unitary inelastic demand.
MEASUREMENT OF PRICE ELASTICITY OF DEMAND
There are five methods to measure the price elasticity of demand.
- Total Expenditure Method.
- Proportionate Method.
- Point Elasticity of Demand.
- Arc Elasticity of Demand.
- Revenue Method.
Total Expenditure Method
Dr. Marshall has evolved the total expenditure method to measure the price elasticity of demand. According to this method, elasticity of demand can be measured by considering the change in price and the subsequent change in the total quantity of goods purchased and the total amount of money spend on it.
Proportionate Method
This method is also associated with the name of Dr. Marshall. According to this method, "price elasticity of demand is the ratio of percentage change in the amount demanded to the percentage change in price of the commodity." It is also known as the Percentage Method, Flux Method, Ratio Method, and Arithmetic Method.
Ed = Proportionate change in Quantity Demanded
Arc Elasticity of Demand
- According to Prof. Baumol: "Arc elasticity is a measure of the average responsiveness to price change exhibited by a demand curve over some finite stretch of the curve".
- According to Leftwitch : "When elasticity is computed between two separate points on a demand curve, the concept is called Are elasticity."
Revenue Method
Mrs.; Joan Robinson has given this method. She says that elasticity of demand can be measured with the help of average revenue and marginal revenue. Therefore, a sale proceeds that a firm obtains by selling its products is called its revenue. However, when total revenue is divided by the number of units sold, we get average revenue. On the contrary, when addition is made to the total revenue by the sale of one more unit of the
commodity is called marginal revenue.
Formula:
Ed = A
A-M
where Ed represents elasticity of demand, A = average revenue and M = marginal revenue.
Perfectly Elastic Demand
When the
percentage change in quantity demanded is infinite even if the percentage
change in price is zero, the demand is said to be perfectly elastic.
Endless demand at given price.
Observe
the graph, price of the goods raised from P to P1 and remained constant. But
the demand curve of the products is increasing from Q1 to Q2 and so on.
Eg:- we can take example as bikes market. In today’s Indian bike market The demand for
bikes is increasing day by day without any effect of price change.
When the percentage change in quantity
demanded is zero no matter how price is changed, the demand is said to
be perfectly inelastic
Observe the graph, price of the
goods changing or raises from P1 to P2 and P3 but there is no change in demand
at Q.
Example:
Emergency services, drugs and essential food
item have perfectly inelastic demand. The price of food item may increase or
decrease; there will be no change in the demand for goods
Or
An example of perfectly
inelastic demand would be a lifesaving drug that people will pay any price
to obtain. Even if the price of the drug were to increase
dramatically, the quantity demanded would remain the same.
Relatively Elastic Demand
When the percentage change in quantity demanded is greater than the percentage change in price, the demand is said to be elastic.
Or
In other words, relatively small changes in price cause relatively large changes in quantity.
Observe the graph, price of the goods increased from P1 to P2 and eventually the demand for the goods decreases from Q1 to Q2. But the proportionate change in price is less than the proportionate change in demand
Example: - there are commodities for which a small change in price will
drastically reduce the amount of the commodity demanded. For example,
air-travel for vacationers is very sensitive to price. An increase in the air
fare will lead the vacationer to choose another mode of transportation like car
or lead him to postpone the vacation plan for the time being. Thus for a rise
in air fare for the vacationers we will see a relatively more drastic reduction
in quantity demanded and hence high price elasticity
of demand.
Relatively Inelastic Demand
More change in the price of the goods but less change in demand for the goods.Observe the graph, price of the goods increased from P1 to P2 and eventually the demand for the goods decreases from Q1 to Q2. The proportionate change in price is more than the proportionate change in demand.
Example: if we observe the
prices of petrol and comparing its demand change with the change in price
levels of petrol (even though the price changes to great extent, there will not
be much change in demand)
WASHINGTON: US motorists drove 1.2 per cent fewer miles in 2011, the lowest level measured since 2003, while concerns about the high cost of gasoline are rising, the government announced Tuesday.
According to Federal Highway Administration figures, last year US drivers drove 57.5 billion km less than they did in 2010.
Since 2008, the distance covered by US drivers, which is calculated by taking into account traffic volume on the highways, has fallen due to the economic crisis and the high price of gasoline.
Unitary Elastic Demand
The proportion of change in demand is equal to proportion of change in price.
Observe the graph, price of the
goods increased from P1 to P2 and eventually the demand for the goods decreases
from Q1 to Q2. The proportionate change in price is equal the proportionate change in demand
Example: The price of digital
cameras increases by 10%, the quantity of digital cameras demanded decreases by
10%. The price elasticity of demand is
(unitary elastic demand).
Problem on PED
The
most common elasticity measurement is that of price elasticity of demand.
It measures how much consumers respond in their buying decisions to a change in
price. The basic formula used to determine price elasticity is
Problems:
If price increases by
10% and consumers respond by decreasing purchases by 20%, the equation computes
the elasticity coefficient as -2. The result is negative because an increase in
price (a positive number) leads to a decrease in purchases (a negative number).
Because the law of demand says it will always be
negative, many economists ignore the negative sign, as we will in the following
discussion.
Problem 1:
If the price of
certain goods falls from 20/- to 10/-, that causes increase in the demand
from43 units to 75 units. Calculate the price elasticity of demand.
Solution:
I f the values are given separately and not in
the percentages, we should apply the following formula model 1
- ∆Q =change in the demand.(difference in demand) =43- 75= 32
- ∆P=change in the price.(difference in the price) =20-10 = 10
- P=initial price. (first price/ old price) =20
- Q=initial demand. (first demand/ old demand)= 43
Here the answer is PED =1.48
We should compare the above value with the
price which is 1%. And its general always.
Hence 1% of the price change causes the 1.48%
change in demand
Easy way to remember:
Elastic means that a change in price leads to a bigger Change in quantity demanded. Think of a rubber band, or elastic, that stretches to a bigger size than its original size. Inelastic means that a change in price leads to a smaller Change in quantity demanded. Unlike a rubber band, it does not stretch bigger.Unit Elastic means that a change in price leads to a one-for-One change in quantity demanded. For example, a doubling of the price leads to a halving of the quantity demanded. Remember by unit, meaning single or one.
No comments:
Post a Comment