ASSIGNMENT QUESTION:

“DISCUSS THE CONCEPT OF “PRICE ELASTICITY OF DEMAND”. EXPLAIN WITH THE HELP OF
GRAPHS.”

ELASTICITY:
The ratio of percentage change in “one variable” to the percentage change in “another
variable” is called elasticity.

PRICE ELASTICITY OF DEMAND:

It is a type of “demand elasticity”. Price elasticity of demand is defined as

“The percentage change in quantity demanded (Qd) divide by the percentage change in price”
It is represented by a symbol “Ed”. The formula for calculating Ed is

Ed = % Change in Quantity Demanded

% Change in Price Level
OR
Ed = ∆Q × 100 / ∆P × 100
Q P

OR Ed = ∆Q × P
∆P Q

So, price elasticity of demand is measure of the extent to which the quantity demanded of good
changes when the price of the good changes, ceteris paribus. In Business, we want to know the
relationship between Qd and Price. We know if we raise price, then Qd will decline, but we don’t
know how much. Elasticity answers the “how much” part of
the question.

The slope of PED is always negative because of negative slope

of demand. The price and Quantity demanded will always
change in opposite directions. While in calculation we ignore
the negative sign and interpret Ed as a positive value.
INTERPRETATION OF PRICE ELASTICITY OF DEMAND:

Price elasticity of demand may be interpreted depending on its value. The possible 5 cases are
as follows:

 If Ed = 1 , Unit elasticity
 If Ed = 0 , Perfectly inelastic
 If Ed = ∞, Perfectly elastic
 If Ed > 1 then Demand is Price Elastic (Demand is sensitive to price changes)
 If Ed < 1 then Demand is Price Inelastic (Demand is not sensitive to price changes)

These cases have been separately explained below

 “Ed = 1”

“If change in price causes an equal change in demand

for the product then the price elasticity of demand is
known as unit elasticity and so Ed = 1”

In such a case,

Percentage change in demand = Percentage change in price

  “Ed = 0”

If quantity demanded does not change at all when price changes,

then demand is perfectly inelastic. In such a case, the value of price
elasticity of demand is zero i.e. Ed = 0

A perfectly inelastic demand is perpendicular to X-axis and it has

zero elasticity.

 “Ed = ∞”

At such a point the price decreases no more and demand increases

infinitely and so does price elasticity of demand. Ed is said to be
perfectly elastic.

A perfectly elastic demand is perpendicular to Y-axis and it has

infinite elasticity.

 “Ed > 1”

When Ed is greater than 1 then demand elasticity is more

elastic and percentage change in quantity demanded is
greater than percentage change in price.
  “Ed < 1”

When Ed is less than 1 then demand elasticity is less

elastic and percentage change in quantity demanded is less than percentage change in price.

SIGNIFICANCE OF PRICE ELASTICITY OF DEMAND:

 Profit maximization requires that business set a price that will maximize the firm’s profit

 Elasticity tells the firm how much control it has over using price to raise profit

 If Ep > 1, then the % Change in Qd > % Change is Price and demand is said to be elastic

o An increase in price will reduce total revenue

o A decrease in price will increase total revenue

 If Ep < 1, then the % change in Qd < % change in price, and demand is said to be inelastic

o An increase in price will increase total revenue

o A decrease in price will decrease total revenue

 If Ep = 1, then the % change in Qd = % change in Price, and demand is said to be unit

elastic

o An increase in price will have no impact on total revenue

o A decrease in price will have no impact on total revenue

DETERMINANTS OF Ep:

A number of factors can thus affect the elasticity of demand for a good:

 Availability of substitute goods

 Proportion of income spent on good
 Necessity
 Duration
 Brand loyalty

FACTORS WHICH MAKE Ep ELASTIC:

 There are many substitutes.

 Substitutes are readily available.
 The good is a luxury- something you can do without.
 The good is important in terms of proportion of income spent of the goods.
 Consumer has plenty of time to search for substitutes.

FACTORS WHICH MAKE Ep INELASTIC:

 There are a few substitutes.

 Substitutes are difficult to obtain.
 The good is a necessity- something you cannot do without.
 The good is unimportant in terms of proportion of income spent of the goods.
 Little time to search for substitutes.