Price Elasticity of Demand Calculation

Price Elasticity of Demand

Price elasticity of demand is an economic measure of the change in the quantity demanded or bought of an item in connection to its price change. As expressed mathematically, it is:

Price elasticity of demand = % Change in Quantity Demanded

                                                             % Change in Price

Calculation of Price elasticity of demand

Example: -

• Suppose, price of a commodity lowers down from $20 to $19 per unit and due to this quantity demanded of the commodity increased from 100 units to 120 units. What is the price elasticity of demand?

→ p= $20

    q= 100 units

 ∆p= $20 - $19= $1

∆q= 120 units -100 units= 20 units

Now,

 EP =

∆q∆p×pq

where, EP= Price elasticity of demand

               q= initial quantity demanded

             ∆q= change in quantity demanded

               p= initial price

             ∆p= change in price

EP= 201×20100

    = 41   = 4%

Therefore, quantity demanded increases by 4% due to fall in price by $1.

Types of degrees of price elasticity of demand

There are 5 types pf price elasticity of demand are:

1) Perfectly Elastic Demand (EP= ∞)

The demand is said to be perfectly elastic, if the quantity demanded rises endlessly with a little fall in cost or quantity demanded tumbles to zero with a little ascent in cost. Therefore, it is otherwise called infinite elasticity.

In the given figure: -

• The demand curve DD is a horizontal straight line parallel to x-axis.      
• It shows that negligible change in price causes infinite fall or ascent in quantity demanded.

2) Perfectly Inelastic Demand (EP= 0)

If the demand remains constant whatever the price may be (i.e. price rises or falls), the demand is said to be perfectly inelastic. So, it is also called as zero elasticity. It has no practical significance and is rarely used in practical life.

In the given figure: -

• The demand curve DD is a vertical straight lie parallel to y-axis.
• It shows that demand remains constant whatever may be the price.
• When price rises from OP to OP2 and falls from OP2 to OP1, the quantity demanded remains constant.

3) Relatively Elastic Demand (EP > 1)

Demand is said to be fairly elastic if the percentage change in demand is greater than the percentage change in price i.e. there is a small change in price, if there is greater change in demand.

For Example: -If the price drops by 5% and demand increases by 10%, then this is the case of elastic demand. The demand for luxury goods such as car, furniture, T.V. etc.  is   considered to be elastic.

In the given figure: -

• The demand curve DD is flat.
• Which shows that the demand is elastic.
• The small fall in price from OP to OP1 has led to greater increase in demand from OM to OM1.
• Similarly, demand will decrease more with small increase in price.

4) Relatively Inelastic Demand (EP< 1)

The demand is said to be relatively inelastic if the percentage change in the quantity demanded is less than the percentage change in price i.e. when there is small change in demand with a bigger change in price.

For Instance: -In the case of inelastic demand, if the price decreases by 10% and demand rises by say 10%. The necessity for everyday goods like salt, rice, kerosene etc is reportedly inelastic.

In the given figure: -

• The demand curve DD is steeper.
• This indicates that the demand is less elastic.
• The greater fall in price from OP to OP1 has led to small increase in demand from OM to OM1.
• Likewise, greater increase in price will lead to small fall in demand.

5) Unitary Elastic Demand (EP= 1)

Demand is stated to be unitary elastic if the percentage change in quantity demanded is equal to the percentage change in price. It is also called unitary elasticity. This form of demand is imagination only, as it is rarely applicable in our realistic lives.

For Example: - 10% change in price will led to exactly 10% change in quantity demanded.

In the given figure: -

• The demand curve DD is rectangular hyperbola that displays a unitary elastic demand.
• The fall in price from OP to OP1 has caused equal proportionate increase in demand from Om to OM1.
• Similarly, when price will increase, the demand will decrease in same proportion.

Importance of Price Elasticity of Demand

1) In the Determination of Output Level

In order to make production profitable, it is essential that the quantity of good and services produced should meet the demand for that product. Assuming that the fluctuations I demand are due to changes in price, therefore knowledge of elasticity of demand is necessary to determine the level of output.

2) In the Determination of Price

The elasticity of demand for a commodity is the basis of its price determination. If the demand for a commodity is inelastic, it may be paid high price by the manufacturer whereas the low price is charged for an elastic demand product. For management, therefore knowledge of elasticity of demand is important for maximising profit.

3) In the Determination of Government Policies

The knowledge of elasticity of demand can also assist in evaluating the government policies with an awareness of demand elasticity. The government needs to consider the elasticity of demand for that product before enforcing a legislative price control on a commodity.

4) In Dumping

A business enters foreign markets to dump its goods in the face of foreign competition because of the elasticity of the demand.

5) In Price Determination of Factors of Production

For the determination of prices for different factors of production, the principle of elasticity for demand is of great importance. Factor of production are paid based on their elasticity of demand. Such as, if the demand of a factor is inelastic, its price will be low, when will be inelastic.

6) In Price Discrimination by Monopolist

The problem of pricing the same products on two markets also depends on the elasticity of demand on each market under the monopoly of discrimination. The selective monopolist sets a low price on the market with elastic demand for his product and pay a high price on a market with a lower elastic demand.

Estimates of price elasticity of demand for inelastic product

Inelastic Product

A good can be said price inelastic when an ascent in price causes a smaller decrease in demand.

Example of Inelastic Product

Salt can be said as an inelastic product because it is a product with no real substitutes. Thus, if the price of salt will increase, there will be a slight decrease in demand of salt, because people will tend to buy salt infrequently than before.

For Example: - If the price of salt rises by 40% whereas demand for salt decreases only by 10%. Price elasticity of demand is 0.25.

The graph depicts that: -

• Change in price has led to a small percentage change in demand for salt.

Estimates of price elasticity of demand for elastic product

Elastic Product

A product can be said elastic when rise in price causes greater fall in demand.

Example of Elastic Product

Dairy Milk Chocolate Bar- If the price of dairy milk bar increases, its demand will decrease as people will switch to alternate type of chocolate.

If price of chocolate rises by 20%, demand falls by 50%. The price elasticity of demand is 2.5%.

The graph depicts that: -

• An increase in price from $10 to $20;
• The quantity demanded decreases from 100 units to 50 units.

The Role of Price Elasticity of Demand for Producers

1) The changes in price effects overall seller’s profit i.e. Total revenue.

2) The market price volatility following supply changes, this is critical for commodity producers who suffer from high price and income swing between periods.

3) The effect on price and quantity demanded by a change of the indirect tax and  the effect on whether the enterprise can pay the consumer some or all the tax.

4) The producers can use the information gathered from price elasticity of demand for price discrimination. A manufacturer wants to place various prices on a single product for example on high and off- road travel, for various sectors of the industry, as well as for many of our national and international airlines.

5) Normally, producers charge higher costs for consumers, whose product demand is price inelastic.

For Example: - The following table gives an example of the relationship between price, quantity demanded & producer’s total revenue.

 The above Table depicts: -

• When price decreases, TR increases.
• The TR is maximum when price is price is $12.
• Therefore, the producer will fix the price of a commodity when TR will be at its maximum.
• Taken into account the elasticity of demand from $20 per unit decreases to $18. The % of demand changes are 40% after a 10% price change and the elasticity of demand is −4 (i.e. very elastic).
• If the demand is price elastic, a decrease in price leads to higher overall consume expenditure, producer revenue.
• Consider a price change from $10 to $8 further down the estimated demand curve. The percentage change in demand 13.3% after a 20% fall in price with an elasticity factor of −0.665. If demand becomes inelastic, a price falls down & total revenue decreases.

Oligopoly Definition (meaning)

The objective market has few sellers. These markets sells homogeneous or differentiated goods. In other words the market structure of oligopoly lies between pure monopoly and monopolistic competition, in which few vendors dominate the market and control the price of goods or products.

Key Features of Oligopoly Market are: -

1) Few Sellers

In Oligopoly market, there are few sellers and many buyers. Few firms that dominate the market has significant influence over the product price.

2) Interdependence

It is one of the main feature of oligopoly system in which the seller must be precautionary when it comes to any action taken by the competing companies. As there are few sellers in the market, all other firms in the industry must abide by price and promotional system change and stay in competition. Each business thus remains alert to others actions and plans to avoid the chaos prior to counter attack. Therefore, sellers in their policy on price output.

3) Advertising

Every company advertises its product on  number of occasions under the oligopoly market with goal of reaching more and more customers. If any company advertises a lot, the other company remains silent. The other company will see that the its clients goes to the other company that promotes their product on a continuous basis. Each company spends a lot of money on advertising activities in order to be in the race of competition.

4) Competition

It is true that there will be an intense competition between sellers with a few players in the market. Any step taken by a company will have significant impact on its competitors. Every seller keeps an eye on its competitor and is ready to go against him.

5) Entry and exit barriers

The companies can leave the industry whenever they want but faces certain obstacles. These barriers might include government licences, patents, economies of large- scale companies, high capital requirements, complex technologies, etc. Also, sometimes the regulation of the government favours existing large companies and therefore, serve an obstacle for new comers.

6) Lack of uniformity

The corporations do not have uniformity in terms of their scale, some of them are large and some of them are small. As there are few companies, any measure taken by one company have a significant effect on other. Growing organisation must therefore, keep a close eye on its counterpart and schedule promotions accordingly.

Automobile market as Oligopoly

Based o oligopoly which offers homogenous products and dominate most of the market, few company’s office the same product on the market the situation is called is called an oligopoly. The car market can be the viewed as the state of the oligopoly market.

There are only a small number of automobile manufacturers who now control the market, justifying one important oligopoly feature of the market. Compared to existing car market environment, a new firm’s entrance into this market will be quite challenging. The well-known car manufacturers such as BMW, Mercedes Benz, Ford, Renault, etc are known in worldwide.

Economic Consequences of Climate Change

Economic costs can be calculated as impacts of climate change. These impacts are particularly suitable to business impacts which are related to market operations that have direct impact on GDP. It is more difficult to calculate monetary non-market effects factors, i.e. impacts on human health and habitats. More problems are listed below with impact estimates: -

Knowledge gaps: -

Calculating distribution impacts requires detailed knowledge of the environment, but these are an important source of climate models uncertainty.

Vulnerability: -

There is little awareness of the potential impacts of the climate change sector in developing countries in contrast with developed countries.

Adaptation: -

Future human and natural climate change adaptation potential can affect how climate change will affect society. Assessments that underestimate or overestimate adaptive ability that results in positive or negative impacts being underestimated or overestimated.

Non-Market Impacts

Climate change is likely to have major non-market consequences, with the most negative impacts anticipated. The effects of climate change in developing countries would cause significant negative health effects.  Were adaptation adequately considered in the few studies examined.  Studies have also shown that those impacts have significantly contributed to the overall cost of climate change in studies that have included health impacts.

Market Sector

In 2019 the International Labour Organization published a report titled: "Working on a warmer planet: The impact of heat stress on labour productivity and decent work", in which it claims that even if the rise in temperature will be limited to 1.5 degree, by the year 2030, Climate Change will cause losses in productivity reaching 2.2% of all the working hours, every year. It reflects 80 million full-time jobs, or $2.400 billion.

Agriculture

According to the assumptions, analyses of the economic impact on the agricultural sector of a doubling of pre-industrial carbon dioxide (CO2) in the atmosphere suggest that this would have marginally negative to moderately positive aggregate effects (i.e. cumulative effects throughout the region).

Other sectors

Climate change, including the dairy, forestry and fishing industries, would affect a variety of other sectors. The coal, insurance, tourism and recreational industries are also division’s that are vulnerable to climate change.  

Australia is achieving our climate change goals through Direct policies that reduce emissions, increase productivity and promote environmental health. The Emissions Reduction Program and Safeguard Mechanism are at the core of these policies. In addition to the renewable energy target, the improvement of energy efficiency, the phasing out of highly potent synthetic greenhouse gases and direct support for investment in the technology and practise of low emissions.

1) Emission Reduction Fund

The Emission Reduction Fund helps Australian industries, societies and farmers in the introduction of greenhouse gases pollution reduction or avoidance steps. The fund gives Australians positive incentives to reduce emissions, reduce energy costs or store carbon in the country. Companies, municipalities and landowners may propose new initiatives with emission reduction strategies that cover all areas of the economy, including energy efficiency enhancement, methane capture from sites and carbon storage in forests and soils.

2) The Renewable Energy Target

The Renewable Energy Target is supporting Australian homes and businesses in installing solar and other technologies of renewable energy, turning our electricity sector into cleaner and more diverse sources and promoting renewable energy growth and jobs. The renewable energy plan calls for sustainable growth in renewable technologies at both large and small scale, supplying over 23% of Australia's renewable energy supply by 2020. Since the scheme started in 2001, renewable energy has invested $10 billion in Australia, with government investing another $20 billion by 2020.

3) The National Energy Productivity Plan

The National Energy Productivity Plan will improve the use of households and businesses in their homes, offices, and industry, including a target to increase Austria's energy productivity by 40% between 2015 and 2030, respectively. The programme must include steps to enable energy choices and promote improved efficiency in facilities, equipment, buildings and transportation. The Plan will be advanced through the Australian Governments ' Energy Council in collaboration with States and territories.

The National Energy Productivity Plan will look at ways to improve the efficiency of vehicles. Australia, including the G-20 Transportation Task Group, will also continue to build capacity for greater vehicle performance through international fora. In Australia, hydrofluorocarbon is quickly going through a domestic phase and will work with other countries to reduce this highly strong global greenhouse gas.

4) Removal of barriers to new technologies

Technology will support our low transformation in emissions. The government must develop a roadmap for low-emission technology to identify innovation, growth and deployment opportunities and challenges for new and emerging technologies across Australia.

The roadmap builds on the significant investments made in science and technology with low emissions in Australia. In about 230 renewable energy projects, the Australian government has committed more than 1 billion dollars and the sector equates this commitment of over 2 billion dollars. The government also supports around 350 scientists in pursuing a dedicated research programme that explores new energy technologies for Australia, through the CSIRO Energy Flagship. Recently announced priorities for science and research would promote a broader range of technical solutions to tackle climate change.

These investments make it possible for Australia to find new solutions to reduce emissions in its homes while simultaneously taking advantage of the emerging international demand for low-emission technologies such as renewables, carbon capture and storage and energy efficiency.

References: -

• Isariyawongse, K. (2009). Essays on strategic behaviour in oligopoly markets.
• Pindyck, R. and Rubinfeld, D. (2018). Microeconomics. Harlow: Pearson Education Limited.
• Department of the Environment and Energy. (n.d.). Retrieved from http://www.environment.gov.au/.
• Wikipedia The Free Encyclopedia. (n.d.). Retrieved from http://www.wikkipedia.com/.