Measurement and Determinants of Price Elasticity of Demand

MEASUREMENT OFPRICE ELASTICITY OF DEMAND

There are three methods of measuring price elasticity of demand. They are:

• Total Outlay Method
• Point Method
• Arc Method

Total Outlay Method

Total outlay method is the major methods of measuring price elasticity of demand. In this method, price elasticity of demand is measured by comparing the total expenditure of the consumers during the changes in the price of goods.

According to Alfred Marshall, "Elasticity of demand can be measured by considering the change in price and the subsequent change in the total quantity of goods purchased and the total amount of money spent on it".

Price elasticity of demand can be measured on the following three bases:-

1. Elasticity of Demand Greater than Unitary (Ep>1)

If the total outlay of a commodity increases due to a small rise in price, then the price elasticity of demand is said to be greater than one, in this condition. Hence, the total expenditure and price of a commodity are inversely related to each other.

2. Elasticity of Demand Equal to Unitary (Ep=1)

If the total expenditure of a commodity is totally irresponsive to the change in the price of a commodity, then the price elasticity of demand is said to be equal to the unitary. In this state, whatever the price of a commodity is, total expenditure of commodity remains constant.

3. Elasticity of Demand Less then Unitary (Ep<1)

If the total expenditure of a commodity falls due to the fall in price, then the price elasticity of demand is said to be less than one in this state. Hence, both total expenditure and price move in the same direction.

The above cases are prescribed with the table below:

In the given table, quantity demanded of a commodity is increasing serially 1, 2, 4, 6, 8 and 10 as the price of a commodity is decreasing 10. 8. 6. 4. 2 and 1 respectively. In the column of total expenditure, it is rising at first and remains constant at certain then later it is decreasing. It shows all three cases based on the price elasticity of demand. These conditions are also mentioned with the help of a diagram.

In the above graph, total expenditure is measured along X-axis and price is measured along Y-axis respectively. The points A and B show the inverse relation between price and total expenditure, where the price increases and total expenditure falls and vice versa. Next point B and C seems to be parallel to price, where there is no change in total expenditure even there is a change in price. Point C and D shows the positive relation between price and total expenditure. When the price increases the total expenditure also increases and when the price decreases the total expenditure also decreases.

DETERMINANTS OF PRICE ELASTICITY OF DEMAND

1. Availability of Close Substitution Goods

Substitution goods like Pepsi and coke, tea and coffee, etc have more elastic demand than the other goods like sugar and salt. For example, if the price of the coke rises, people will switch over Pepsi, which is a close substitute. So the demand for coke is elastic. On the other hand, sugar and salt do not have their close substitute. So, their price elasticity is less.

2. Luxuries Goods

The elasticity of demand depends on nature of a commodity. Demand for luxuries goods is more elastic than other goods. Luxuries goods like a sofa, car, television, etc can be postponed when their price rises. So, their price elasticity is more elastic.

3. Necessities Goods

The consumption of necessities goods cannot be postponed like a luxuries goods. Necessities goods include clothes, foods, vegetable, medicine, etc. Such goods are less elastic as they cannot be substitute with other goods.

4. Consumers Habit

The habit of the consumer varies according to the consumer. Some of the consumers have the habit of smoking. But the rise in the price of the cigarette does not affect much the demand. The demand for habituating goods is less elastic.

5. Range of alternative uses of commodity

When the price of multi-use goods decreases, the consumer increases its uses. For example, the consumption of electricity can be used for several uses like cooking, heating, lighting, etc. Therefore, the price elasticity demand for an electricity is more elastic at low cost.

(Karna, Khanal, and Chaulagain)(Khanal, Khatiwada, and Thapa)(Jha, Bhusal, and Bista)

Bibliography

Jha, P.K., et al. Economics II. Kalimati, Kathmandu: Dreamland Publication, 2011.

Karna, Dr.Surendra Labh, Bhawani Prasad Khanal and Neelam Prasad Chaulagain. Economics. Kathmandu: Jupiter Publisher and Distributors Pvt. Ltd, 2070.

Khanal, Dr. Rajesh Keshar, et al. Economics II. Kathmandu: Januka Publication Pvt. Ltd., 2013.