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There are basically four ways by which we can measure price elasticity of demand. These methods are
1.
Percentage method
2.
Total outlay method
3.
Point method
4.
Arc method
1.
Percentage Method
Percentage method is one of the commonly used approaches of
measuring price elasticity of demand under which price elasticity is measured
in terms of rate of percentage change in quantity demanded to percentage change
in price.
According to this method, price elasticity of demand can be
mathematically expressed as
For an example: When the price of a commodity was Rs 10 per unit, its demand in the market was 50 units per day. When the price of the commodity fell to Rs 8, the demand rose to 60 units. Here, price elasticity of demand can be calculated as
Unlike price elasticity of supply, price elasticity of demand is always a negative number because quantity demanded and price of the commodity share inverse relationship. This means, higher the price, lower will be the demand, and lower the price, higher be the demand of the commodity.
2. Total Outlay Method
Total outlay method, also known as total expenditure method of
measuring price elasticity of demand was developed by Professor Alfred
Marshall. According to this method, price elasticity of demand can be measured
by comparing total expenditure on a commodity before and after the price
change.
While comparing the expenditure, we may get one of three
outcomes. They are
Elasticity of demand will be greater than unity (Ep > 1)
When total expenditure increases with fall in price and
decreases with rise in price, the value of PED will be greater than 1. Here,
rise in price and total outlay or expenditure move in opposite direction.
Elasticity of demand will be equal to unity (Ep = 1)
When total expenditure on commodity remains unchanged in response
to change in price of the commodity, the value of PED will be equal to 1.
Elasticity
of demand will be less than unity (Ep < 1)
When total expenditure decreases with fall in price and increases
with rise in price, the value of PED will be less than 1. Here, price of
commodity and total outlay move in same direction.
|
Cases |
Price (P) |
Quantity
demanded (Q) |
Total outlay
or expenditure (E = PXQ) |
Price
elasticity of demand (PED) |
|
I |
6 |
1 |
6 |
PED = 10/6,
> 1 |
|
5 |
2 |
10 |
||
|
II |
4 |
3 |
12 |
PED = 12/12,
= 1 |
|
3 |
4 |
12 |
||
|
III |
2 |
5 |
10 |
PED = 6/10,
< 1 |
|
1 |
6 |
6 |
When the information from the above table is plotted in the graph,
we get graph like the one shown below.
In the graph, total outlay or expenditure is measured on the
X-axis while price is measured on the Y-axis. In the figure, the movement from
point A to point B shows elastic demand as we can see that total expenditure
has increased with fall in price.
The movement from point B to point C shows unitary elastic demand
as total expenditure has remained unchanged with the change in price.
Similarly, the movement from point C to point D shows inelastic demand as total
expenditure as well as price has decreased.
Total outlay method of measuring price elasticity of demand does
not provide us exact numerical measurement of elasticity of demand but only
indicates if the demand is elastic, inelastic or unitary in nature. Therefore,
this method has limited scope.
3. Point Method
The point method of measuring price elasticity of demand was also
devised by prof. Alfred Marshall. This method is used to measure the price
elasticity of demand at any given point in the curve.
According to this method, elasticity of demand will be different
on each point of a demand curve. Thus, this method is applied when there is
small change in price and quantity demanded of the commodity.
According to this method, price elasticity of demand (PED) is
mathematically expressed as
However, the method of calculating PED depends upon the nature of the demand curve. These methods are explained below.
Price
elasticity on a linear demand curve
If the demand curve is of linear nature, PED is simply calculated by applying the expression given above,
i.e.
In the figure, MN is a linear demand curve and P is the mid-point of the curve.
Therefore, at point P,
In the same way,
Price elasticity on a non-linear demand curve
If the demand curve is of non-linear or convex nature, then a tangent line is drawn at the point of which the PED is to be measured. Then PED is once again calculated as
In the given figure, DD is a non-linear demand curve. If P is the point where we want to measure price elasticity, then we have to first draw a tangent through that point. Thus, tangent MN has been drawn through point P. Now, PED can be measured as
4. Arc Method
Any two points on a demand curve make an arc, and the coefficient
of price elasticity of demand of an arc is known as arc elasticity of demand.
This method is used to find out price elasticity of demand over a certain range
of price and quantity. Thus, this method is applied while calculating PED when
price or quantity demanded of the commodity is highly changed.
In the figure, we can see that AB is an arc on the demand curve
DD, and point C is the mid-point on AB. If we followed point method to measure
PED at points A and B in the curve DD, we get different coefficients as a
result of using different bases. To avoid this discrepancy, elasticity is
measured by taking mean values of price and quantity demanded in arc method.
The average of price and quantity demanded is calculated as
Once the average value of price and quantity demanded are
determined, PED at point C can be calculated by applying following formula
Where,
ΔQ = change in quantity demanded = Q2 – Q1
Q1 = initial quantity demanded
Q2 = new quantity demanded
ΔP = change in price = P2 – P1
P1 = new price
P2 = initial price
Adopted from: https://www.businesstopia.net/economics/micro/measuring-price-elasticity-demand-percentage-total-outlay-point-and-arc-methods
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