Price Elasticity of Demand PDF

Compulsory Reading Week 4 Price elasticity of Demand Elasticity of demand is the change in the quantity demanded of a particular product because of the changes in any of the factors affecting the demand i.e., it is the percentage change in a variable (quantity o...

Compulsory Reading Week 4 Price elasticity of Demand Elasticity of demand is the change in the quantity demanded of a particular product because of the changes in any of the factors affecting the demand i.e., it is the percentage change in a variable (quantity of demand) because of a unit percentage change in the other variables (factors effecting demand). This elasticity of demand is of three different types: 1. Price elasticity of demand 2. Income elasticity of demand 3. Cross elasticity of demand. 1. Price elasticity of demand Price elasticity of demand is the change in the quantity demanded because of the change in the price of the underlying product. We see these kinds of instances almost every day where the change in the price has affected the quantity demanded. For ex.: fall in the price of the tickets of a particular film increases its demand thereby leading to greater sales and so on. It could also be calculated as the percentage change in the quantity demanded divided by the percentage change in the price of that product. If we express it mathematically, It would be Ped = (Δq / Δp)*(p/q) Where, Δq represents the change in the quantity demanded for a particular product Δp) represents the change in the price a particular product P represents the initial price of the demanded goods Q represents the initial quantity of the demanded goods Let’s take an example to understand this concept. If the price of a product increases from Rs 10 to Rs 12 resulting in the decrease in the quantity demanded from 50 units to 40 units, what would be the price elasticity of demand? So based on the above we can calculate Δq = q2 – q1 = 40 – 50 = - 10 units i.e., there is a decrease in the demand by 10 units Δp = p2 – p1 = Rs. 12 – Rs. 10 = Rs. 2 per unit i.e., change in the price of Rs -2 per unit Initial quantity q = 50 units Initial price p = Rs 10 per unit Thus the price elasticity of demand according to the above formula Ped = (Δq / Δp)*(p/q) would be Ped = (-10 / 2 )*(10/50) = -1 So what does this imply? It simply says that for an x% change in the price there would be a y% change in the quantity demanded for a product i.e., for a 10 % change in the price there would be a 10 % change in the quantity demanded for a particular product, in the example we just saw. Think of one real life scenario where this concept of Ped (price elasticity of demand) will have relevance. Note down the answer to the above and we would resume as soon as you are done. Some of you might have thought of the discounts offered by super markets and how it affected their sales. You could also think of the increase in the prices of tomatoes and onions decreasing their demand / consumption and so on. Both of the above are correct as in both the cases the consumer either prepones or postpones the consumption depending upon the price. He/she prepones the consumption if the prices go down and postpones the consumption the prices go up. Many of you might have also thought about the increase in the prices of various essential commodities like milk, salt, rice, wheat, etc. leading to the decrease in their demand. They are incorrect as these are essential commodities and have to be purchased irrespective of their price. Understanding this price elasticity of demand is of great relevance to consumers, producers, the government and various other stakeholders. Let us now try to go in depth and understand the value of Ped Types of Price Elasticity of Demand Based on the values that we get for the Ped (which could range -∞ to 0), the price elasticity of the demand for the commodities can be classified from Perfectly elastic to Perfectly inelastic; i.e., The demand would be: perfectly elastic if the Ped value is -= -∞, it would be relatively elastic if the Ped value is greater than 1. it would be unitarily elastic if the Ped value is equal to 1, it would be relatively inelastic if the Ped value is less than 1 and the demand would be perfectly inelastic if the Ped value is equal to 0. Types Value Perfectly Elastic Demand (Ped = -∞)  Relatively Elastic Demand (Ped >1) Unitary Elastic Demand (Ped = 1) Relatively Inelastic Demand (Ped 1) In this case the quantity demanded changes in greater percentage as compared to the price. So, if the prices changes by 10%, the quantity demanded could change by any value greater that 10%. Examples: All consumer durables and FMCG products exhibit this type of behavior. Unitary Elastic Demand (Ped =1) In this case, the change in the quantity demanded is exactly the same as the change in the price. So, a 10% change in the price would lead to a 10% change in the quantity demanded of the product. Examples: Electronic goods, digital cameras , etc. Relatively Inelastic Demand (Ped