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Measurement of Elasticity of Demand

There are three methods for measuring elasticity of demand.
• Outlay method
• Point method
• Arc method

Outlay Method

Prof. Marshall developed outlay method to measure the degree of elasticity of demand.
According to this method, we examine whether the total outlay of the consumer or revenue of the
seller has changed after the price change. Total outlay of total revenue = Price X Quantity
purchased or sold. If the total outlay remains unchanged, after the change in price, the demand is
said to be unit elastic (ep = 1). When with a rise in price, if total outlay falls or with a fall in price
if total outlay rises, elasticity of demand is greater than unity (ep > 1). The price and total outlay
moves in the opposite direction.

When with a rise in price, if total outlay rises and with a fall in price if total outlay falls,
elasticity of demand is said to be less than unity (ep < 1). In this case we notice that price and
total outlay move in the same direction.

Table 1.Total outlay Method
Price Total outlay Type of demand
Increase Constant (e = 1)
Decrease Constant Unitary elastic
Increase Decreases (e >1)
Decrease Increases Relatively elastic
Increase Increases (e<1)
Decrease Decreases Relatively inelastic

ep = Percentage Change in Quantity Demanded
Percentage Change in Price

ep = ΔQ/ Q ΔP/ P = (ΔQ/ Q) X (P/ΔP) Where Q is the original quantity ΔQ is the quantity after the price change P is the original price ΔP is the new price ΔQ = (Q2 – Q1) ΔP = (P2 – P1) Illustration Find the price elasticity of demand from the following data.) 10 100 1000 I 20 75 1500 40 65 2600 e <1 10 100 1000 II 20 50 1000 40 25 1000 e =1 10 100 1000 III 20 45 900 40 15 600 e >1 . Price of sugar : 10 20 40 10 20 40 10 20 40 Quantity Purchased: 100 75 65 100 50 25 100 45 15 Solution Price of Sugar Quantity Demanded Total Outlay (in Rs.) (in Kg.

13 When price change from 10 to Rs.40 in the IInd case .20 in the IInd case Q1 = 100 Q2 = 50 P1 = 10 P2 =20 ΔQ = (Q2 – Q1) = 50-100 = 50 ΔP = (P2 – P1) = 20 – 10 = 10 ep = ΔQ/ Q ΔP/ P ep = (ΔQ/ Q) X (P/ΔP) = (50/100) X (10/10) = 0.40 in the Ist case Q1 = 75 Q2 = 65 P1 = 20 P2 =40 ΔQ = (Q2 – Q1) = 65-75 = 10 ΔP = (P2 – P1) = 40 – 20 = 20 ep = ΔQ/ Q ΔP/ P ep = (ΔQ/ Q) X (P/ΔP) = (10/75) X (20/20) = 0.5 When price change from 20 to Rs.When price change from 10 to Rs.20 in the Ist case Q1 = 100 Q2 = 75 P1 = 10 P2 =20 ΔQ = (Q2 – Q1) = 75-100 = 25 ΔP = (P2 – P1) = 20 – 10 = 10 ep = ΔQ/ Q ΔP/ P ep = (ΔQ/ Q) X (P/ΔP) = (25/100) X (10/10) = 0.25 When price change from 20 to Rs.

Q1 = 50 Q2 = 25 P1 = 20 P2 =40 ΔQ = (Q2 – Q1) = 25-50 = 25 ΔP = (P2 – P1) = 40 – 20 = 20 ep = ΔQ/ Q ΔP/ P ep = (ΔQ/ Q) X (P/ΔP) = (25/50) X (20/20) = 0.66 .5 When price change from 10 to Rs.20 in the IIIrd case Q1 = 100 Q2 = 45 P1 = 10 P2 =20 ΔQ = (Q2 – Q1) = 45-100 = 55 ΔP = (P2 – P1) = 20-10 = 10 ep = ΔQ/ Q ΔP/ P ep = (ΔQ/ Q) X (P/ΔP) = (55/100) X (10/10) = 0.55 When price change from 20 to Rs.40 in the IIIrd case Q1 = 45 Q2 = 15 P1 = 20 P2 =40 ΔQ = (Q2 – Q1) = 15-45 = 30 ΔP = (P2 – P1) = 40 – 20 = 20 ep = ΔQ/ Q ΔP/ P ep = (ΔQ/ Q) X (P/ΔP) = (30/45) X (20/20) = 0.

Note that the length of line segment DB is more than AD.Point Elasticity Method Point elasticity measures price elasticity at various points on the demand curve. ep < 1 because eb<ae. Note that the length of line segment EB is less than AE. When a point is plotted on the demand curve. ep = §. and U stands for upper segment. ep = EB / AE. ep = AB / 0. At point B. At point A. Arc Elasticity of Demand Arc method is used to measure the elasticity of demand for big change in price. ep > 1 because db>ad. it divides the curve into two segments. L stands for lower segment. The point elasticity is measured by the ratio of the lower segment of the curve below the given point to the upper segment of the curve above the point. ep = 0. The formula for measuring price elasticity f demand through arc method is . At point E. ep = db / ad. At point c. price elasticity ep = CB/AC = 1. note that the line segment CB and AC are of equal length. At point D. Point elasticity = lower segment of the demand curve below the given point Upper segment of the demand curve above the given point e = L U Where e stands for elasticity. ep = 0 / AB.

electric chimneys etc. The Nature of Commodity: Demand for necessary goods do not change with changes in their price.1..g. e. On the other hand. consumers would postpone their purchase and when their price falls.Q1)/ (Q + Q1) (P .5 Arc method is the most popular method of measuring elasticity of demand. . demand for luxury goods is elastic. consumers are induced to purchase them e. They are as follows:- 1.P1) / ( P +P1) ( 100 -3001)/ (100 + 300) (10.ep= Original quantity.quantity after change/ Original quantity + quantity after change ---------------------------------------------------------------------------------------------- Original price – price after change/ Original price + price after change ep= ( Q .5) / (10 +5) (.P1) / ( P +P1) Illustration Measure arc elasticity of demand for the following data. 5/- Quantity purchased at new price = 300 units ep= ( Q .Q1)/ (Q + Q1) (P . Factors Determining Price Elasticity of Demand The price elasticity of demand depends on several factors. 10/- Quantity purchased at this price = 100 units Price after change = Rs. When their prices increase..200/400) (5/15) (. demand for salt or medicine. demand for air conditioners.200/400) X (15/5) = . Original price of a commodity = Rs.g. and therefore their demand is inelastic.

a consumer thinks of replacing a car when its price falls. 3. demand for toilet soaps. 4.. When their price rises. matches etc. a slight increase in its price drives away consumers to purchase other substitutes e.g.2. are of inelastic demand.Possibility of postponement of use: If consumers can postpone the use of a commodity.g. Substitutes: Demand for those goods. Extent of Use: Demand for commodities. which have limited use. its demand will be inelastic e. their consumption will be restricted to most important use. which have several substitutes. which have a variety of use is elastic. Urgent wants create inelastic demand. Ranges of Prices: At very high level of prices and low ranges of prices. Commodities..g. demand for salt. is usually elastic. demand is inelastic. 6. On the other hand. Durability of Goods: Durable goods are elastic because consumers replace them when their price falls and postpone their purchase when price increase e. .Proportion of Income Spent: If the proportion of income spent on a particular commodity is very small. 7. because a slight reduction in the price of substitute goods leads to substitution effect and attracts consumers to goods whose price has fallen. its demand will be elastic.. 5.