Lecture-12

Demand Analysis

Learning Objective: Measurement of Price elasticity of demand

Percentage method:
Ed

=(-)

percentage change in quantity

demanded
percentage change in price

Ed

=(-)

Q / Q
P /P

Ed

= (-)

P Q
Q P

Point elasticity of demand:

Price elasticity is the proportionate change in quantity demanded to the proportionate
change in price.
Q/Q

Ep =

P/P

= Q/Q X P/ P

---------------- (i)

In the figure below, when price falls from OP to OP1, quantity demanded rises from OQ
to OQ1.This change in price by PP1 causes change in quantity demanded by QQ1.
Substituting these in equation (i) above, we get,

Ep = QQ1 / PP1 X OP/ OQ

Since in figure below QQ1= MR1 and PP1 = RM and OP =QR
Therefore Ep = MR1/RM X QR/OQ --------------- (ii)
Now take triangles RMR1 and RQT
MR1R = QRT
(Corresponding
s)
RMR1 =
RQT
(right
s)
MRR1 = RQT
(Common
s)
Therefore triangles RMR1 and RQT are similar; a property of similar triangles is that
their corresponding sides are proportional to each other. From this it follows that:
MR1/RM =QT/QR
Writing QT/QR in place of MR1/RM in equation (ii) we get
Ep = QT/QR X QR/OQ
= QT/OQ
Now, in triangle OT1T QT is parallel to OT1, therefore,
QT/OQ =RT/RT1
Ep =QT/OQ = RT/RT1
Hence from above it is found that price elasticity at point R on the straight line demand
curve T1T is
= RT/RT1 = Lower segment/Upper segment
If the point R exactly lies in the middle of the demand curve (as shown in figure below)

the elasticity at this point will be equal to one. If the point lies above the middle point R
say S then elasticity at this point will be ST/ RT1 i.e. more than one. Similarly if this
point lies below the middle point R then it will be less than one. At point T it will be zero
and at point T1 it will be infinity.
If the demand curve is non linear as shown in the figure below then elasticity at a
point R ins measure by drawing a tangent line to the given point R It is equal to
RT/T1R.

Arc Elasticity Method :

3

 When the price change is somewhat large or we want to measure elasticity over
an arc of the demand curve rather than on a specific point, then the measure is
called Arc elasticity method. Say we are interested to measure elasticity of
demand between points A and B as shown in the figure below on the demand
curve DD. For such cases concept of Arc elasticity is used in which we use the
average of two prices i.e. original as well subsequent and average of two
quantities i. e. original as well as subsequent. Thus the formula for elasticity is as
given below.
Q/Q+Q1/2

Ep =

P/P+P1/2

Ep = Q/Q+Q1 X P+P1/ P or

Q/ P X P+P1/ Q+Q1

Q(P+P1) / P(Q+Q1)

Revenue Method:
Price elasticity of demand can also be measured with the help of average and
marginal revenue curves with the following formula.
Ep = A/ A-M where A= average revenue, M=marginal revenue
In the figure below, revenue is shown on Y-axis and quantity on X-axis AB is the
average revenue curve or demand cure and AN marginal revenue curve At point P
elasticity of demand is calculated as
Ed = Lower portion/ upper portion or PB/PA
PMB and AEP are similar, so ratio of their sides is also equal
Ed = PB/PA =PM/AE -------------- (i)

AET and TPL are congruent triangles, so PL=AE. By substituting PL in place of AE in

equation (i)
Ed = PM/Pl
Because PL = PM- LM , hence
Ed = PM/ PM-LM , where
PM =AR and LM =MR, so Ed = A/A-M So if the value of Ed is one it means elasticity
is unitary, if it is more than one, then elasticity is more than one and if less than one then
less than unitary.