The price elasticity of demand is measured by the percentage increase or decrease in quantity demanded in relation to the percentage increase or decrease in price.
In other words, if the percentage increase or decrease is greater than increase or decrease in price the demand is elastic and the co-efficient of price elasticity is greater than 1. If the percentage increases or decrease in quantity demanded is equal to the percentage increase or decrease in price then the price elasticity in unitary and the price elasticity are equal to 1. On the contrary, if the percentage in crease or decrease in quantity demanded is less than the percentage increase or decrease in price then the price elasticity of demand is in elastic and the price elasticity of demand is less than 1. As the demand curve slopes down the relationship between the price and quantity demanded can be depicted by a diagram and see how the shape of the demand curve changes if the price changes for the three categories of price elasticity of demand such as elastic, unitary and inelastic.
Elastic Demand Curve
Demand Curve When the Price Elasticity of Demand is Unitary
Inelastic Demand Curve
As depicted in the above diagrams of elastic, unitary and inelastic demand curves one can see the slope of the curve is getting steeper when the price elasticity of demand is decreasing. In addition, in the elastic demand curve diagram the total revenue is increasing when the price reduces from P1 to P2 because the quantity is increasing more compared to the price reduction and there fore the total revenue increases if the demand is elastic. In the second diagram when the price elasticity is equal to 1 the total revenue do not change because the price change percentage and quantity change percentage is equal. It can be seen from the unitary price elasticity demand curve diagram when the price is reduced from P1' to P2' the quantity is increased by the same percentage from Q1' to Q2'. And the total revenue does not change when the price reduced or increased. However, as depicted in the inelastic demand curve when the price is reduced from P'1 to P'2 the quantity demanded is increased by a lesser percentage than the price reduction and there fore the total revenue is reduced. There fore the consequences of price increase or reduction when the price elasticity is elastic, unitary and inelastic can be summarized as below.
Factors Affecting Price Elasticity of Demand
The price elasticity of demand depends on several factors. The most important factors are whether the product concerned is produced by a monopoly industry or by a competitive industry structure where there exist many substitutes. For example if say in a mobile telephone market there exist many companies competing and customers can switch to other companies with little switching costs then the demand for the product will be most probably elastic. However, if there is considerable switching costs then the demand will be inelastic. In contrast if say railway company provides services say in peak periods then with little competition from other railway companies and there exist little choices for such services the demand for rail services in peak periods will be inelastic. However, in off peak periods the demand for rail services becomes elastic because the customers can use other modes of transport if the prices are high and they have more choices in off peak periods. The other factor, which affects elasticity of demand, is whether it is a necessary product or luxury product. Necessary products are mostly inelastic compared to luxury products. However, the degree of elasticity differ for necessary depends on substitutes as well as for luxury products and whether the market structure is competitive, monopoly or imperfect competition or oligopoly market structure. The other factors affecting the elasticity of demand is the consumer buying habits. For example the demand for alcohol and Cigarettes tend to be inelastic than elastic. The other factor, which affects the price elasticity of demand, is the percentage of income spent on by consumers of a product.
If the percentage is higher then the elasticity tends to be more elastic than when the percentage of income spent on it is lesser. In addition, in short term most products are inelastic in demand than in the longer term because the customers can change to other choices comparing prices and quality in the loner term than in the short term. As well, when the general economic condition is positive the demand tends to be more inelastic compared to when the general economic condition is negative.
Implication of Price Elasticity of Demand for Businesses and Government
As discussed above the price elasticity of demand is crucial for businesses because the price elasticity of demand has implications for setting prices of their goods and services as the price elasticity of demand has an impact on total revenue and yield management. For example a monopoly company is setting its prices for its services and say its peak period demand is inelastic and off peak period demand is elastic then setting higher prices in peak period and setting low prices in off peak periods and using price discrimination can maximise revenue or yield. In addition, by considering the factors affecting the price elasticity of demand a business can determine to some extent the price elasticity of demand and there fore enable to set prices on the basis of the price elasticity information in to consideration. For example if a company knows that switching cost affects the price elasticity of demand by increasing the switching cost of their services they can make the demand inelastic charge higher prices because the customers will not be able to switch to other companies easily if switching costs are higher. The telecommunication service providers can use this information to maintain their market share by knowing that switching costs affects the price elasticity of demand and by increasing the switching costs they can restrict customers choosing services form their competitors. In addition, in competitive markets the businesses must consider price as a competitive strategy when there are similar products and substitutes for their products because as explained above the price elasticity in these conditions will be mostly elastic and there fore affect sales then other factors. That is the businesses must consider the market structure because as explained above these
factors affect the price elasticity of demand and it has impact on the yield level of the company.
