Financing and Marketing Management

Unit 11 - Elasticity

11.2. Price elasticity of demand
Price elasticity measures the responsiveness of potential buyers to changes in price. It is the ratio of percentage change in quantity demanded in response to a percentage change in price. As such, it measures the extent of movement along the demand curve.

Price elasticity = proportionate change in amount demanded

---------------------------------------------------------------

Proportionate change in price.

=change in demand change in price

------------------------- + ----------------------

Amount demanded price

Suppose the price of a particular brand of a radio set falls from Rs. 500 to Rs. 400 each, i.e., 20 per cent fall. As a result of this fall in price, suppose further that the demand for the radio sets has gone up from Rs. 400 to 600, i.e., 50 per cent. Elasticity of demand will be 50/20 or 2.5 percent. The concept of price elasticity can be used in comparing the sensitivity of the different types of goods (e.g., luxuries and necessaries) to change in their prices. For example, by this means we may find that the price elasticity for food grains, in general, is 0.5, whereas for fruit it may be1.5. This means that the demand for food grains is less sensitive to price changes than demand for fruit. Food is a necessary of life and people must buy almost the same quantity, even if its price has risen. The consumer can, however, economize in fruit or any other commodity included in the family budget.
The elasticity of demand is always negative, although by convention it is taken to be positive. It is negative because change in quantity demanded is in opposite direction to the change in price. That is a fall in price is followed by rise in demand, and vice versa.
In these terms, then, if the elasticity is greater than 1 demand is said to be elastic; between zero and one demand is inelastic and if it equals one, demand is unit-elastic. A perfectly elastic demand curve is horizontal (with an elasticity of infinity) whereas a perfectly inelastic demand curve is vertical (with an elasticity of 0).