PRICE ELASTICITY OF DEMAND BY Deepthi J Thomas

Contents What is Elasticity of demand? What is price elasticity of demand? Perfectly Elastic Demand curve Perfectly Inelastic demand Curve Applications of Price Elasticity of demand Factors Influencing Price Elasticity of Demand Income Elasticity of Demand Point Elasticity

What is Elasticity of Demand? Elasticity of Demand is the degree to which consumer’s demand for a product responds to changes in price, availability of resources or other factors ( like luxury goods)

What is Price Elasticity of Demand? The Price Elasticity of demand compares the percentage change in quantity demanded to the percentage change in price as we move along the demand curve.

Measure of price Elasticity of demand: Price elasticity of demand is calculated by dividing the proportionate or percentage change in quantity demanded by the proportionate change in price. PED = % change in quantity demanded % change in price

Perfectly Elastic Demand Curve In a perfectly elastic demand curve the change in quantity demand is proportionately larger than the change in price. This means that an increase in price would result in a decrease in revenue, and a decrease in price would result in an increase in revenue From the above demand curve you can see how an extremely small change in price would result in an infinitely large shift in quantity demanded.

Perfectly Inelastic Demand Curve In a Perfectly Inelastic Demand Curve the quantity demanded is proportionately smaller than the change in price. An increase in price would result in an increase in revenue and a decrease in price would result in a decrease in revenue. From the above demand curve you can see how a very large change in price would have no impact on the quantity demanded.

Application of Price Elasticity of Demand The Price Elasticity of demand can be applied in a variety of problems where you want to know the quantity demanded or the revenue given a contemplated change in price.

Factors Influencing the Price Elasticity of demand Availability of Substitutes: The greater the number of substitute products , greater is the elasticity. Degree of Necessity or Luxury : Luxury products tend to have more elasticity than necessity products (life saving drug) Time Period Considered: Elasticity tends to be greater over the long run because consumers have more time to adjust to price changes.

Determinants of Price Elasticity of Demand Demand tends to be more inelastic : If the good is a necessity. If the time period is shorter. The smaller the number of close substitutes. The more broadly defined the market (many buyers and sellers)

Demand tends to be more elastic : If the good is a luxury. The longer the time period. The larger the number of close substitutes. The more narrowly defined the market. (few buyers and sellers)

Income Elasticity of Demand The income Elasticity of demand is a measure of how much the demand for a good is affected by changes in the consumer’s income. It allows us to determine whether the good is a normal or inferior good as well as measure how intensely the demand for the good responds to change in income. IED = % change in quantity demanded % change in income

When the income elasticity of demand is positive the good is a normal good – that is the quantity demanded at any given price increases as income increases. When the income elasticity of demand is negative, the good is an inferior good – that is the quantity demanded at any given price decreases as income increases.

Conclusion Thus I conclude by saying that price elasticity of demand is an important aspect to know how consumers preferences or responsiveness to a particular product changes with respect to an increase or decrease in price.

References http://economics.about.com/cs/micfrohelp/a/priceelasticity.htm http://www.netmba.com/econ/micro/demand/elasticity/price/ http://www.tutor2u.net/economics/content/topics/elasticity/elastic.htm Micro Economics Paul Krugman, Robin Wells

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