Elasticity of Demand
SARBJEET
Lecturer in Economics
Contents
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Meaning of Elasticity
Meaning of Price Elasticity
Types of Price elasticity
Perfectly Elastic
Perfectly Inelastic
Unitary Elastic
Elastic
Inelastic
Methods of measuring Price elasticity
Elasticity
A general definition:
“Elasticity” is a (standard) measure of the
degree of sensitivity ( or responsiveness) of
one variable to changes in another variable.
The price elasticity of Demand
The (self) price elasticity of demand is a
measure of the degree of sensitivity of
demand to changes in the (self) price, ceteris
paribus
Determining Price Elasticity
Percentage Change in Quantity
Ep =
Percentage Change in Price
Change in Quantity
Quantity
Ep =
Change in Price
Price
• The elasticity measure is a ratio between two
percentage measures: the percentage change
in one variable over the percentage change in
another variable
• The terms elastic and inelastic demand do not
indicate the degree responsiveness and
unresponsiveness of the quantity demanded
to a change in price. The economists
therefore, group various degrees of elasticity
of demand into five categories. (1) Infinitely
elastic, (2) Perfectly inelastic, (3) Unitary
elasticity, (4) Relatively elastic, and (5)
Relatively inelastic demand.
• Perfectly elastic demand: A demand is perfectly elastic when a
small increase in the price of a good its quantity to zero. Perfect
elasticity implies that individual producers can sell all they want at a
ruling price but cannot charge a higher price. If any producer tries
to charge even one penny more, no one would buy his product.
People would prefer to buy from another producer who sells the
good at the prevailing market price of $4 per unit. A perfect elastic
demand curve is illustrated in fig. 6.1. It shows that the demand
curve DD/ is a horizontal line which indicates that the quantity
demanded is extremely (infinitely) response to price. Even a slight
rise in price (say $4.02), drops the quantity demanded of a good to
zero. The curve DD/ is infinitely elastic. This elasticity of demand as
such is equal to infinity.
• Perfectly inelastic demand: When the
quantity demanded of a good dose not
change at all to whatever change in price, the
demand is said to be perfectly inelastic or the
elasticity of demand is zero. For example, a
30% rise or fall in price leads to no change in
the quantity demanded of a good.
• Unitary elasticity of demand: When the quantity
demanded of a good changes by exactly the same
percentage as price, the demand is said to has a unitary
elasticity. For example, a 30% change in price leads to 30%
change quantity demand =
30% /30% = 1 One or a one
percent change in price causes a response of exactly a one
percent change in the quantity demand. In this figure (6.3)
DD/ demand curve with unitary elasticity shows that as the
price falls from OA to OC, the quantity demanded increases
from OB to OD. On DD/ demand curve, the percentage
change in price brings about an exactly equal percentage in
quantity at all points a, b. The demand curve of elasticity is,
therefore, a rectangular hyperbola.
• Elastic demand: If a one percent change in price
causes greater than a one percent change in
quantity demanded of a good, the demand is said
to be elastic. Alternatively, we can’ say that the
elasticity of demand is greater than I. For
example, if price of a good change by 10% and it
brings a 20% change in demand, the price
elasticity is greater than one.
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• Inelastic demand: When a change in price
causes a less than a proportionate change in
quantity demand, demand is said to be
inelastic. The elasticity of a good is here less
than I or less than unity. For example, a 30%
change in price leads to 10% change in
quantity demanded of a good, then:
• Measurement of Price Elasticity of Demand
• There are three methods of measuring price
elasticity of demand.
• (1) Total revenue method
• (2) Geometrical method
• (3) Arc method
• Total Revenue Method (also called Total Expenditure Method):
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• The total revenue method finds total revenue (total expenditure) by
multiplying the quantity sold by the selling price of the good. When
a firm increase the price of a good, will its total sales revenue
increase or decrease? Well, this depends upon the elasticity of
demand for the good- For example, if the demand for a good is
elastic or (> 1), a rise in the price of a good decreases its total
revenue and a decrease in price increases the total revenue of the
firm. If the demand for the good is inelastic (< 1), a rise in the price
of a good increase total revenue and a fail in price decreases total
revenue of the firm. In case the elasticity of demand, for
• the good is equal to unity, a rise or fall in price of good leaves total
revenue unchanged. The total revenue methods is now explained
with the help of curves below:
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Geometric Method:
(a) Measurement of elasticity at any point on a linear demand curve.
The price elasticity of demand varies along a linear demand curve. In the middle of demand curve,
the price elasticity is unitary. The total revenue is maximum at this point. Any point above the
middle point has elasticity greater than one (Ed > 1). Here price reduction leads to an increase in
total revenue (or expenditure). At any point below the mid point, the elasticity is less than 1
(Ed< 1). Price reduction leads to decrease in the total revenue and increase in price increases total
revenue. The measurement, of elasticity at any point on a linear demand curve is now explained
with the help of figure 6.9.
In this figure, the demand curve is linear. It has a unitary elasticity at the mid point d. Elasticity is
greater than one (> 1) above the mid point. Below the midpoint the elasticity is less than one. By
applying the percentage method of measurement of elasticity ΔQ / ΔP x p / q, we measure the
elasticity at any point, on the linear demand curve.
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Arc Elasticity:
The point method is applicable only for measuring infinitesimal changes in the price. If the price
change is quite large, than the Arc Method is used to measure the price elasticity of demand. The
arc elasticity is a measure of average elasticity. It is the elasticity at the midpoint of the chord that
connects two points A and B on the demand curve. Arc elasticity is calculated by using the following
formula.
Ep = Δq / Δp . p1 + p2 / q1+ q2
Δq = denotes change in quantity
Δp = denotes change in price.
q1 = signifies initial quantity, q2 denotes new quantity. .
p1 = stands for initial price, p2 denotes new price.
Graphic presentation of measuring elasticity using the arc method.
In this fig. (6.11) It is shown that at a price of Rs.10, (P1) the quantity of demanded of apples is 5 kg.
per day (Q1), When its price falls from $10 to $5, (P2) the quantity demanded Increases to 12 Kg
(Q2) of apples per day. The arc elasticity of AB part of demand curve DD' can be calculated as under.
The arc elasticity is more than unity.