Price Elasticity Of Demand Depends On Various Factors. Explain Each Factor With The Help Of An Example?

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Answer 1:

The concept of price elasticity of demand is commonly used in economic literature. Price elasticity of demand is the degree of responsiveness of quantity demanded of a good to a change in its price. Precisely, it is defined as:

"The ratio of proportionate change in the quantity demanded of a good caused by a given proportionate change in price".

Formula:

The formula for measuring price elasticity of demand is:

Price Elasticity of Demand = Percentage in Quantity Demand
Percentage Change in Price

Ed = Δq X P
Δp Q

Example:

Let us suppose that price of a good falls from $10 per unit to $9 per unit in a day. The decline in price causes the quantity of the good demanded to increase from 125 units to 150 units per day. The price elasticity using the simplified formula will be:

Ed = Δq X P
Δp Q

Δq = 150 - 125 = 25

Δp = 10 - 9 = 1

Original Quantity = 125

Original Price = 10

Ed = 25 / 1 x 10 / 125 = 2

The elasticity coefficient is greater than one. Therefore the demand for the good is elastic.

Types:

The concept of price elasticity of demand can be used to divide the goods in to three groups.

(i) Elastic. When the percent change in quantity of a good is greater than the percent change in its price, the demand is said to be elastic. When elasticity of demand is greater than one, a fall in price increases the total revenue (expenditure) and a rise in price lowers the total revenue (expenditure).

(ii) Unitary Elasticity. When the percentage change in the quantity of a good demanded equals percentage in its price, the price elasticity of demand is said to have unitary elasticity. When elasticity of demand is equal to one or unitary, a rise or fall in price leaves total revenue unchanged.

(iii) Inelastic. When the percent change in quantity of a good demanded is less than the percentage change in its price, the demand is called inelastic. When elasticity of demand is inelastic or less than one, a fall in price decreases total revenue and a rise in its price increases total revenue.