Elasticity of Demand: Measurement and Classification - Essay Example

Abhisek.M.Jain 30/11/2008 Elasticity of Demand INTRODUCTION Elasticity of demand measures the extent of inverse relationship between the price and the quantity demanded of the commodity. According to Alfred Marshall, “the elasticity of demand in a market is great or small according as the amount demanded increases much or little for a given rise in price”. (Alfred Marshall, Principle of Economics(1890)) TYPES OF ELASTICITY OF DEMAND Elasticity of demand can be classified into different kinds such as 1. Price elasticity of demand. 2. Income elasticity of demand. 3. Cross elasticity of demand. PRICE ELASTICITY OF DEMAND In the words of Paul A. Samuelson, “price elasticity of demand indicates the responsiveness of quantity demanded to the changes in market price.” (Anthony Samuelson, Foundations of Economic Analysis, 1947). Price elasticity of demand is the ratio of the proportionate change in the quantity demanded of a commodity X, to a given change in its price. Price elasticity of demand= Percentage change in quantity demanded of commodity X Percentage change in the price of commodity X Percentage change in quantity demanded= Change in the quantity demanded of commodity X Original demand Percentage change in the price of commodity = Change in the price of the commodity X Original price Price elasticity of demand is classified into 5 types 1. Perfectly elastic demand When a small change in price causes an infinite amount of change in demand it is called as perfectly elastic demand. D is the perfectly elastic demand curve. The price of the commodity does not change but the quantity demanded changes infinitely. 2. Perfectly inelastic demand It is also called as zero elasticity of demand. Whatever be the change in price there is no change in demand. In the figure D is the perfectly inelastic demand curve. D is a vertical straight line remaining parallel to Y axis. The demand does not change in spite of the increase in price. 3. Unit elasticity of demand It refers to a equal or proportionate change in the demand for a given change in the price so that the money spend on the commodity remains constant. 4. Elastic demand Elastic demand represents a more than proportionate change in demand for a small change in price. 5. Inelastic demand Inelastic demand represents a small change in quantity demanded for a big change in price. 2. INCOME ELASTICITY OF DEMAND Income elasticity of demand indicates the responsiveness of the quantity demanded to the change in the income of the consumer. The income of the consumer plays a very dominating role in determining the demand for a product. Income elasticity of demand = Percentage change in the quantity demanded of commodity X Percentage in the income of the consumer 3. CROSS ELASTICITY OF DEMAND Cross elasticity of demand is the responsiveness of the quantity demanded of the commodity X to the change in the price of the commodity Y. The commodity Y may be a substitute or a complimentary good for commodity X. For example, tea and coffee are substitutes and pen and ink are complimentary good. A reduction in the price of tea will lead to the reduction in the demand for coffee and increase in the demand for tea, as the people would reduce the consumption of coffee because tea is available at a cheaper rate. Cross elasticity of demand= Percentage change in the quantity demanded of commodity X Percentage change in the price MEASUREMENT OF ELASTICITY OF DEMAND Elasticity of demand can be measured through the following 4 methods 1. Percentage method. 2. Point elastic method. 3. Total outlay method. 4. Arc elasticity method. PERCENTAGE METHOD In this method the elasticity of demand is measured by the percentage change in the quantity demanded for a given percentage change in the price. Price elasticity of demand according to the percentage method= Percentage change in the quantity demanded Percentage change in price POINT ELASTICITY OF DEMAND Prof. Marshall introduced the geographical method of measuring elasticity of demand. Elasticity at a point in a straight line demand curve is known as point elasticity of demand. The numerical value of elasticity of demand on demand curve may vary from zero to infinity. A demand curve does not have the same elasticity at all points in the demand curve. Elasticity of demand according to point elasticity= Lower segment of the demand curve Upper segment of the demand curve TOTAL OUTLAY METHOD Total outlay method is also known as total expenditure method or total revenue method. Total outlay means the total amount spent by a consumer on the purchase of a commodity. Total expenditure of the buyer is compared both before and after the change in the price. On this basis the demand is ascertained to be elastic, unitary or less elastic. Total outlay = Price * Quantity demanded ARC ELASTICITY When elasticity is measured between two points on the same demand curve which is not a straight line demand curve, it is known as arc elasticity. The segment between any two points on a demand curve makes an arc. Arc elasticity is the average of the two elasticity measures at two points, forming the arc in the demand curve. FACTORS AFFECTING ELASTICITY OF DEMAND 1. Income of the individual. 2. Nature of the commodity. 3. Availability of substitutes. 4. The extent of its uses. 5. Postponement of the consumption of the commodity. 6. Habits. 7. Level of prices. 8. Time factor. 9. Joint demand. CONCLUSION The concept of elasticity of demand plays a very important role in the following aspects 1. Determination of the volume of output by the producers Producers will produce more of those goods whose demand is Inelastic. Thus the volume of total production of various goods in an economy depends upon their elastic and inelastic demand. 2. Price discrimination to be adopted by the monopolists. Elasticity of demand for a monopolist may be different for different consumer groupings. A monopolist fixes a higher price where demand is less elastic and a lesser price where demand is more elastic. 3. The amount of taxes to be imposed by the government. The concept of elasticity of demand is very much useful for the finance minister. Generally goods whose demand is inelastic are subjected to higher amount of taxes and the goods whose demand is elastic are subject to a lower amount of tax. 4. Determination of wages by the employers. Employers fix the wages depending upon the elasticity or inelasticity of labours. Unskilled labour is inelastic in supply. Hence, wages are low. Skilled and specialised labour supply in inelastic. Wages will be higher in this case. Therefore the concept of elasticity of demand plays vital role in each and every field of economics. REFERENCES 1. Venkatsamy, Laxman(1998), “Demand and Supply” Chennai: Macmillan. 2. Shankaran, Raju(2001), “Elasticity of Demand and Supply” Mumbai: Premeire 3. ICMBA, “Price Elasticity of Demand” Available at http://www.netmba.com/econ/micro/demand/elasticity/price/ 4. Gupta, Das(1997), “Micro Economics” Chennai: Macmillan. Read More