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Managerial Economics - Demand Analysis

Price Elasticity - Demand Analysis

   Posted On :  28.05.2018 10:52 pm

The response of the consumers to a change in the price of a commodity is measured by the price elasticity of the commodity demand.

Price Elasticity
 
The response of the consumers to a change in the price of a commodity is measured by the price elasticity of the commodity demand. The responsiveness of changes in quantity demanded due to changes in price is referred to as price elasticity of demand. The price elasticity of demand is measured by dividing the percentage change in quantity demanded by the percentage change in price.



For example:
 
Quantity demanded is 20 units at a price of Rs.500. When there is a fall in price to Rs. 400 it results in a rise in demand to 32 units. Therefore the change in quantity demanded is12 units resulting from the change in price of Rs.100.
 
The Price Elasticity of Demand is = 500 / 20 x 12/100 = 3

The Determinants Of Price Elasticity Of Demand

 
The exact value of price elasticity for a commodity is determined by a wide variety of factors. The two factors considered by economists are the availability of substitutes and time. The better the substitutes for a product, the higher the price elasticity of demand.. The longer the period of time, the more the price elasticity of demand for that product. The price elasticity of necessary goods will have lower elasticity than luxuries.
 
The elasticity of demand depends on the following factors:
 
1.      Nature of the commodity: The demand for necessities is inelastic because the demand does not change much with a change in price. But the demand for luxuries is elastic in nature.

2.      Extent of use: A commodity having a variety of uses has a comparatively elastic demand.

3.      Range of substitutes: The commodity which has more number of substitutes has relatively elastic demand. A commodity with fewer substitutes has relatively inelastic demand.

4.      Income level: People with high incomes are less affected by price changes than people with low incomes.

5.      Proportion of income spent on the commodity: When a small part of income is spent on the commodity, the price change does not affect the demand therefore the demand is inelastic in nature.

6.      Urgency of demand / postponement of purchase: The demand for certain commodities are highly inelastic because you cannot postpone its purchase. For example medicines for any sickness should be purchased and consumed immediately.

7.      Durability of a commodity: If the commodity is durable then it is used it for a long period. Therefore elasticity of demand is high. Price changes highly influences the demand for durables in the market.

8.      Purchase frequency of a product/ recurrence of demand: The demand for frequently purchased goods are highly elastic than rarely purchased goods.

9.      Time: In the short run demand will be less elastic but in the long run the demand for commodities are more elastic.

The following are the possible combination of changes in Price and Quantity demanded. The slope of each combination is depicted in the following graphs.
 
1.Relatively Elastic Demand (Ed >1) a small percentage change in price leading to a larger change in Quantity demanded.


2.Perfectly Elastic Demand (Ed = ∞) a small change in price will change the quantity demanded by an infinite amount.



3.Relatively Inelastic Demand (Ed < 1) a change in price leads to a smaller percentage change in quantity demanded.



4.Perfectly Inelastic Demand (Ed = 0) the quantity demanded does not change regardless of the percentage change in price.



5.Unit Elasticity of Demand (Ed =1) the percentage change in quantity demanded is the same as the percentage change in price that caused it. 



Tags : Managerial Economics - Demand Analysis
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