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Degrees of Price Elasticity of Demand


Go to solution Solved by Pavan Chinta,

Price Elasticity of Demand is a concept in economics to measure the elasticity (or change) in the demand of a product or service with respect to change in price (when everything else is kept constant). It is calculated as the ratio of percentage change in demand to the percentage change in price. Following are the five degrees of price elasticity

Perfectly Elastic Demand

Perfectly Inelastic Demand

Relatively Elastic Demand

Relatively Inelastic Demand

Unitary Elastic Demand

 

An application-oriented question on the topic along with responses can be seen below. The best answer was provided by Pavan Chinta on 3rd December 2019.

Question

Q 214. The simplest method to explore improvement in margins is to understand the degree of price elesticity of demand for your company's products. Explain the five degrees and provide examples of products that are likely to have them. 

 

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It is well known that the demand (or supply) of a product is greatly influenced by the price change. This change in the demand, however is not uniform. Sometimes, a minor change in the price would leads to a great change in the demand quantity and in other cases, even a larger change in the price will have minimal impact on the demand.

“Elasticity of demand, also referred to as Price elasticity of demand is the degree responsiveness of quantity in demand (of a product and/or a commodity) due to the alteration of its price. It can be mathematically expressed as below:

 

Price Elasticity of demand = % change in the quantity demanded/% change in the price i.e, the percentage change in the quantity demand divided by the percentage change in the price.

 

This variation in the demand could be broadly categorised into Elastic and Inelastic Demand.

The demand is considered as Elastic if a change in the price would significantly impact the demand. For e.g.., Reduction in the prices in cars (by offering the discounts and incentives) have greatly increased the sales.

Similar way, the demand is considered to be inelastic if the price alteration has no proportionate increase in the demand. For e.g., confectioneries where the price does not have a proportionate relationship with the demand of these goods.

Since this broader classification doesn’t give an understanding of the degree of responsiveness (or unresponsiveness), the elasticity of demand is further divided into 5 categories as explained below:

(1)    Perfectly Elastic Demand:

It is also called as Infinite elasticity. The demand is said to be perfectly elastic when a small change in the process leads to a much significant effect on the demand of the good(s). In other words, a short fall in the prices would cause an infinite increase in the demand and vice versa.

This relationship is not very common and has very little importance in the practical world.

For example, in the commodity trading, even a slight change in the price would increase or decrease the demand significantly. Another such example is in food or restaurant industry, a slight increase in the price of the usual menu would make the customers chose from the other options or seek for alternatives.

 

(2)    Perfectly Inelastic Demand:

This is also known as Zero Elasticity. This is the condition where the demand remains uninfluenced by price changes. In general terms this is when the demand remains constant. For example, Automotive fuels (Petrol, diesel), Gold, Pharmaceuticals are few examples where this principle is observed.

 

(3)    Relatively Elastic Demand:

As the name indicates, Relatively elastic demand is observed when the percentage change in the demand is higher than the percentage change in the price of the commodity, which means, the proportionate increase in the demand is much higher than the fall in the price of the respective product. For instance, even a small percentage decline in the real estate prices can create a higher percentage demand. Other examples include the luxury goods like Phones, electronics automobiles etc.,

 

(4)    Relatively Inelastic Demand:

Relatively inelastic demand can be observed when the percentage demand is lesser than the percentage change in the price. Here, the price has a very less influence on the demand quantity. Even with a higher fall in the price, we may not see a significant increase in the demand. The products or goods for daily use usually fall into this category (like Rice, wheat, Gas etc.,)

 

(5)    Unitary Elastic Demand:

This is also called as Unitary elasticity and is often considered imaginary. This is observed when the percentage change in the demand is almost the same as the percentage change in the price. In other words, change in the demand percentage is equal to the change in the price percentage.

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