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2018

Economics for Decision Makers : Price Elasticity of Demand

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What is Demand?

In layman's terminology, to demand something means to ask for something. However, in economics, the term "demand" has a special meaning. In economics, "Demand" of a commodity or service is the quantity that people are willing and able to buy at a certain price, per unit of time. Hence, the demand of any goods or service depends on two factors namely the ability of a person to buy such goods or services at a given price and willingness of that person to pay the given price for the commodity or service. Demand is a very complex phenomena in an economy. Many factors like price of the commodity/service, total supply, price of related goods / services, demographics etc. affect the determination of demand in the economy.

 What is Elasticity?

In economics, the concept of elasticity is closely associated with demand. It measures the degree of relation between demand of a commodity / service and changes in its price. In other words we can say that elasticity tries to measure the degree of responsiveness of demand of a commodity / service with changes in price level.
There are five type of elasticity of demand in relation to price as given in below chart:
Let us discuss briefly about each type of Price elasticity of demand:

1. Perfectly Elastic Demand:
When demand is perfectly elastic in response to price, a small change in price causes a significant change in demand. In other words, the percentage of change in price is smaller than responsive percentage change in demand. A small rise in price can lead to very deep fall in the demand of the given product or service. Perfect Elasticity of demand is possible only in the perfectly competitive markets. Perfect elasticity of demand is represented as straight horizontal curve on a graph.

2. Perfectly Inelastic Demand:
Perfectly Inelastic Demand is the opposite case of Perfectly Elastic Demand. When demand is perfectly inelastic to changes in price, the proportion of increase or decrease in demand with price change is very minor. This means, a very big increase in price may result in to a very slight fall in demand or no change in demand at all. This kind of demand elasticity is generally seen in a monopoly market only. Perfectly Inelastic Demand is represented with a vertically straight line on a graph.

3. Relatively Elastic Demand:
Demand of a commodity / service in response to its price is said to be relatively elastic when proportionate change in demand is higher than proportionate change in price level. For example, if a rise of 35% in price leads to 40% fall in demand, such demand is called relatively elastic to price change.

4. Relatively Inelastic Demand:
Relatively Inelastic Demand is the opposite case of relatively elastic demand. When demand is relatively inelastic, the proportionate change in demand is lower than proportionate change in price level. For example, if a fall of 20% in price would result in a 10% increase in demand, the demand is said to be relatively inelastic to price change.

5. Unitary Elastic Demand:
When change in demand and price are in the same proportion, the demand is said to be Unitary Elastic to price change. In other words, a rise in price by certain percentage would result into a fall in demand by same percentage and vice versa. For example, a 25% increase in price would result in 25% fall in demand.

Summary:

Price elasticity of demand can be summarised with the help of below table:

Sr. No. Type of Price elasticity of Demand Description Example
Change in Price Change in Demand
1 Perfectly Elastic Demand A small change in price results in proportionally very high change in demand 2% increase in price 80% decrease in demand
2 Perfectly Inelastic Demand A very high change in price would lead to very minor change in demand 80% increase in price 2% decrease in demand
3 Relatively Elastic Demand Change in demand is proportionally higher than change in price 20% fall in price 30% rise in demand
4 Relatively Inelastic Demand Change in demand is proportionally lower than change in price 30% fall in price 15% rise in demand
5 Unitary Elastic Demand Proportional change in price and demand are the same 20% rise in price 20% fall in demand

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