Measurement of Price Elasticity of Demand

Price Elasticity of Demand is a crucial concept in economics that helps to understand how the quantity demanded or supplied of a good responds to changes in its price. Businesses and policymakers can make informed decisions about pricing strategies, tax policies, and market regulations by measuring price elasticity. This article delves into the methods of measuring demand and supply price elasticity, providing a comprehensive overview of the techniques used to gauge consumer and producer responsiveness to price changes. Understanding these Price Elasticity of Demand methods not only aids in predicting market behaviour but also enhances strategic planning and economic forecasting.

What Is Price Elasticity of Demand?

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Measurement Price Elasticity of Demand Methods

1. Percentage Method : This method involves calculating the percentage change in quantity demanded relative to the percentage change in price. The formula is:

1. Total Outlay Method : Also known as the total expenditure method, this approach examines the change in total revenue (price multiplied by quantity demanded) resulting from a price change. If total revenue moves in the opposite direction of the price change, demand is elastic; if it moves in the same direction, demand is inelastic.
2. Point Method : This method calculates elasticity at a specific point on the demand curve using the derivative of the demand function concerning price. The formula is: PED=(ΔPΔQ​)×(QP​)

1. Arc Method : This approach calculates elasticity over a range of prices by taking the average starting and ending prices and quantities. It is useful for measuring elasticity over larger price changes. The formula is: PED=((P1​+P2​)/2P2​−P1​​)((Q1​+Q2​)/2Q2​−Q1​​) ​

Price Elasticity of Demand Factors

1. Number of Substitutes Available : When a product has numerous substitutes or brands, its demand elasticity is high because customers can easily switch to another brand in response to price changes. For instance, chocolates are available in many brands, allowing consumers to choose alternatives based on price differences.
2. Product Cost about Income : Demand elasticity increases when the cost of a product represents a significant portion of a consumer's income. If a family's income fluctuates, their demand for such products and services will also change, making the demand more elastic.
3. Brand Loyalty : Consumers loyal to a particular brand are less sensitive to price changes, resulting in inelastic demand for that brand's products. Even if the price increases, loyal customers continue to buy the product.
4. Necessity Goods : Items such as medicines and gasoline are considered necessity goods with inelastic demand. Consumers must purchase these items regardless of price changes, so their demand remains relatively unresponsive to price fluctuations.

Types of Price Elasticity of Demand

1. Perfectly Elastic Demand : This occurs when even a tiny change in price leads to an infinite change in the quantity demanded. In this case, the demand curve is horizontal, indicating that consumers will only buy at one price and no other.
2. Perfectly Inelastic Demand : This happens when the quantity demanded remains constant regardless of price changes. The vertical demand curve shows that consumers will purchase the same amount regardless of price.
3. Relatively Elastic Demand : Demand is considered relatively elastic when a small change in price leads to a larger percentage change in quantity demanded. This indicates a high sensitivity to price changes, often seen in goods with many substitutes.
4. Relatively Inelastic Demand : In this case, a change in price results in a smaller percentage change in quantity demanded. Consumers are less responsive to price changes, which is common for necessities with fewer substitutes.
5. Unitary Elastic Demand : This occurs when a change in price leads to an equal percentage change in quantity demanded. Here, the total revenue remains constant when the price changes.

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Measurement of Price Elasticity

1. Point Elasticity: This method uses specific price and quantity points to calculate the elasticity at a single point on the supply curve.

• Qs1 = Initial quantity supplied
• Qs2 = New quantity supplied after price change
• P1 = Initial price
• P2 = New price after price change

1. Mid-Point Elasticity: This method considers the average change in price and quantity between two points on the supply curve, providing a more accurate picture for non-linear curves.

• PES > 1 (Elastic Supply): A larger percentage change in quantity supplied occurs compared to the price change. Suppliers are very responsive to price fluctuations.
• PES < 1 (Inelastic Supply): A smaller percentage change in quantity supplied occurs compared to the price change. Suppliers need to be more responsive to price fluctuations.
• PES = 1 (Unit Elastic Supply): The percentage change in quantity supplied equals the percentage change in price.

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