Introduction
Till now, we have discussed in detail about the concept of demand curve. We also discussed in detail the concept of elasticity of demand, specifically focusing on the Price Elasticity of Demand. Under price elasticity of demand, we discussed the case of a linear demand curve. We studied that at different price point or price levels along a linear demand curve, the price elasticity differs. Price Elasticity of Demand greater than 1 is said to be elastic demand, price elasticity of demand less than 1 is said to be inelastic demand and equal to 1 is said to be unitary elastic.
Then we moved on to cases of constant elasticity along a demand curve. Under constant elasticity of demand, we studied three cases which are Vertical Demand Curve, Horizontal Demand Curve and Rectangular Hyperbola. For a Vertical Demand Curve, the price elasticity is Perfectly Inelastic. For Horizontal Demand Curve, the price elasticity of demand is Perfectly Elastic and for Rectangular Hyperbola Demand Curve, the price elasticity is Unitary Elastic.
Factors Deciding Price Elasticity of Demand
The price elasticity of demand for any product, may be a good or service, depends on the nature of the good as well as the close substitutes available for the good. So we will discuss both of them individually.
1) Nature of the Good
If a good is of a nature which cannot be easily done away with if not consumed or provided for, then the price elasticity of demand for that good is bound to be inelastic. For example, if the given goods considered are food and are essential for living, then consumer cannot avoid to consume as they are necessary for the survival. Thus goods essential for living, have a demand which is very less responsive to change in price. And demand for such goods does not even change much if the prices go up. On the other hand, at the same time, if the goods belong to luxurious category, the demand for such goods are highly responsive to the change in prices, i.e., demand for a luxurious good can go drastically down if the price of the same increases. So in summary, price elasticity of demand for necessities is price inelastic while price elasticity of demand for luxuries is likely price elastic.
2) Availability of Close Substitutes
If for a good, an easy and close substitute is available, to which consumer can shift in order to fulfill their needs and wants, then for such a good, the demand would be highly responsive to change in price. So the price elasticity of demand for goods of which close substitutes are easily available have their demand price elastic. For example, is prices of a particular type of pulses go up then consumers will switch to other types of pulses which are close substitute of the former and hence demand of the pulse whose prices have increased could go down drastically. So in summary, the demand for good having a close substitute available easily is price elastic while demand for goods having no close substitute available easily is price inelastic.
Relationship Between Elasticity and Expenditure
Elasticity of demand as we know, is the responsiveness of the demand for a good to a change in price of that good. Expenditure here, is the total sum that the consumer incurs on a good that is the quantity demanded by the consumer for a good times its price.
Now here, what we are studying is, whether the expenditure on a good increases or decreases with respect to increase or decrease in price of that good. And the link between the increase or decrease in expenditure as a result of price change, is the level of price elasticity of demand for that good i.e., how responsive is the demand for that good given a change in price.
In simple terms, the change in expenditure on a good as a result of change in price change of that good, directly depends on how responsive the demand of that good is to a change in price.
For understanding the same in a lucid way, we will divide the discussion into cases and will discuss each of them individually as follows.
Case 1 - Increase in price of the good
If the % decrease in quantity is less than the % increase in price, the expenditure on the good will go up.
Case 2 - Increase in price of the good
If the % decrease in quantity is greater than the % increase in price, the expenditure on the good will go down.
Case 3 - Increase in price of the good
If the % decrease in quantity is equal to the % increase in price, the expenditure on the good will remain same.
Case 4 - Decrease in price of good
If the % increase in quantity is greater than the % decrease in price, the expenditure on the good will go up.
Case 5 - Decrease in price of good
If the % increase is quantity is less than the % decrease in price, the expenditure on the good will go down.
Case 6 - Decrease in price of good
If the % increase in quantity is equal to the % decrease in price, the expenditure on the good will remain same.
Each of the above cases can be summarized in the following table.
From the above table mentioning different cases, we can conclude the following;
1) If the % change in quantity is greater than the % change in price i.e. the good is price elastic, then the expenditure on the good will change in the opposite direction of the change in price.
2) If the % change in quantity is less than the % change in price i.e., the good is price inelastic, then the expenditure on the good will change in the same direction of the change in price.
Conclusion
Relationship Between Elasticity and Expenditure
Elasticity of demand as we know, is the responsiveness of the demand for a good to a change in price of that good. Expenditure here, is the total sum that the consumer incurs on a good that is the quantity demanded by the consumer for a good times its price.
Now here, what we are studying is, whether the expenditure on a good increases or decreases with respect to increase or decrease in price of that good. And the link between the increase or decrease in expenditure as a result of price change, is the level of price elasticity of demand for that good i.e., how responsive is the demand for that good given a change in price.
In simple terms, the change in expenditure on a good as a result of change in price change of that good, directly depends on how responsive the demand of that good is to a change in price.
For understanding the same in a lucid way, we will divide the discussion into cases and will discuss each of them individually as follows.
Case 1 - Increase in price of the good
If the % decrease in quantity is less than the % increase in price, the expenditure on the good will go up.
Case 2 - Increase in price of the good
If the % decrease in quantity is greater than the % increase in price, the expenditure on the good will go down.
Case 3 - Increase in price of the good
If the % decrease in quantity is equal to the % increase in price, the expenditure on the good will remain same.
Case 4 - Decrease in price of good
If the % increase in quantity is greater than the % decrease in price, the expenditure on the good will go up.
Case 5 - Decrease in price of good
If the % increase is quantity is less than the % decrease in price, the expenditure on the good will go down.
Case 6 - Decrease in price of good
If the % increase in quantity is equal to the % decrease in price, the expenditure on the good will remain same.
Each of the above cases can be summarized in the following table.
From the above table mentioning different cases, we can conclude the following;
1) If the % change in quantity is greater than the % change in price i.e. the good is price elastic, then the expenditure on the good will change in the opposite direction of the change in price.
2) If the % change in quantity is less than the % change in price i.e., the good is price inelastic, then the expenditure on the good will change in the same direction of the change in price.
Conclusion
In this session, we discussed in detail the factors deciding the price elasticity of demand. And we also discussed in detail the relationship between the change in expenditure of the consumer with respect to the change in price depending upon the price elasticity of demand.
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