Price Elasticity of demand

Price Elasticity of demand

Price elasticity of demand is the measure of the percentage change in price to the percentage change in quantity demanded. With price elasticity of demand, it can be measured as whether the demand for goods is elastic or inelastic. If the demand for goods is elastic there will be a change in the demand due to change in price whereas if the demand for the goods is inelastic there won’t be change in the demand due to change in price.

Explanation:

Price elasticity of demand is used by economists to understand how change in price affect the demand of the product and on that basis, the strategy of formulation of price is determined. According to the experts, demand for inelastic goods like basic necessity goods does not change due to increase or decrease in price whereas demand for elastic goods like luxury goods can change i.e. increase or decrease due to change in the price. Sometimes with minor increase in the price, the demand decreases drastically it is called perfectly elastic demand or perfectly inelastic demand. There are five types of price elasticity of demand namely perfectly elastic demand, perfectly inelastic demand, relatively elastic demand, relatively inelastic demand and unitary elastic demand.

Let’s see the scenario in each type of demand:

Perfectly elastic demand:

In Perfectly demand, price is constant but there is change in the quantity demanded.

Perfectly inelastic demand:

In perfectly inelastic demand, demand is constant in spite of change in price.

Relatively Elastic Demand:

In Relatively Elastic Demand, there is more change in demand due to minor change in price.

Relatively Inelastic demand:

In Relatively Inelastic Demand, there is less change in demand due to more change in price.

Unitary Elastic Demand:

In Unitary Elastic Demand, change in demand is equal to change in price.

Formula

While calculating price elasticity of demand we ignore the negative sign as we know that the price and the quantity demanded is inversely correlated.

Practical common numerical:

Example 1: There is an increase in the price of Television set by 10% and as a result quantity demanded is decreased by 5%. Compute the price elasticity of demand and also determine the type of elasticity?

Solution:

Price Elasticity of demand = Percentage change in demand / Percentage change in price

                                              = 10% / 5%

                                              = 2 %

As change in demand is less than change in price the price elasticity of demand is said to be perfectly inelastic demand.

Example 2: The price of a chocolate decreases from $15 to $10 per unit and the quantity demanded increases from 20 to 30 units. Find price elasticity coefficient.

Advantages of Price Elasticity:

Advantages of Price Elasticity of demand are as under:

  • Helps in deciding price of the product:

Price Elasticity of demand helps in determining the price of the product to the seller by taking into account the demand for the product and its response to change in price.

  • Aid in deciding the Governmental policies:

It helps the government in deciding the policies and deciding which basic facilities at low price the government should provide.

  • Helps in generating revenue:

Price-elastic products help to generate more revenue by cutting or reducing the price.

  • Helps in Forecasting the demand:

It helps the companies in forecasting the demand by determining in which type of product of demand they fall and accordingly the companies plan the supply or production of the product.

Disadvantages of Price Elasticity:

Disadvantages of Price Elasticity of demand are as under:

  • Uncertainty:

As the market demand and consumer choice changes with the introduction of new products, it is therefore uncertain to determine the demand or to forecast the demand due to changes in the market conditions.

  • Competitive Disadvantage:

The different Competitors decide the different price which will create competitive disadvantage for the industry.

  • Affected by other factors:

It is affected by other factors as well such as substitutes, composite products, gifts and schemes attached to the products etc.

Final Thought:

Price Elasticity of demand is the measure of percentage change in demand due to percentage change in price and formula for price elasticity is % change in demand divided by percentage change in price. The price elasticity determines which type of elasticity is like there are five types of price elasticity and on the basis of which the price of the product is decided. But sometimes it’s not only the price of the product which affects the demand but there are other factors also like substitutes etc.

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Related Articles

  1. Demand
  2. Determinants of Demand
  3. Law of Demand
  4. Rationale of law of demand

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