The concept of point elasticity is used when we want to know relative price elasticity of demand at a given point on the demand curve to make some decisions about price variation. We try to know impact on revenue which is total of multiplying price with quantity demand (PxQ).
Dominick Salvatore defines point elasticity of demand as:
“The price elasticity of demand at a particular point on the demand curve.”
(Source: Managerial Economics in a Global Economy, 7th Edition)
To simplify the concept, we take mid-point of the demand curve as a point (C) where elasticity is unity (Ed=1). Elasticity of demand decreases (Ed<1) when we move to the right direction from point C and increases (Ed>1) the other way around.
The elasticity is measured by placing points on a given graph that’s why it is also called graphic method.
There are a number of ways to calculate it. The sophisticated methods seem too complicated but simple ones are more popular. We can calculate price elasticity of demand on different points of linear or non-linear demand curves.
In above graph we suppose to sell 80 items for $80.00. We also suppose unitary elasticity of demand at point C by taking it as a mid-point on the curve. We can calculate point elasticity on different points of the demand curve by using this formula:
The elasticity at point C can be calculated as:
Ed = CD/CA = 40/40 = 1
Elasticity at point D can be calculated as under:
Ed = ED/AD = 20/60 = 0.33 (<1)
Elasticity at point B can be calculated as under:
Ed = BE/BA = 60/20 = 3 (>1)
By applying this method we find out that elasticity of demand at different points along a linear demand curve is different. At high prices, the demand is elastic while at lower the demand is relatively inelastic. At mid-point the elasticity is unit elastic.
In this graph the elasticity on DD’ demand curve at point C can be measured by drawing a tangent (a line which touch the curve but does not intersect). At point C the elasticity would be:
Ed = BM/MO = BC/CA = 40/20 = 2 (>1).
On this point the elasticity is greater than unity. It lies above the demand curve DD’.
At point C, the elasticity is greater than unity and it situated
We have been using round numbers in our calculations to simplify things for the visitors. However, in a real-life situation, a change in price may result in a very small decrease, or increase in quantity demanded or the revenue generated. It is possible that you decrease the price of your product by 10% and be able to increase your revenue just by 2%.
In such situations, it becomes a very critical choice to go for a change in price. It depends upon costs of your product to decide what is better for your revenue generation.
Secondly, there are certain situations when elasticity goes infinite or falls to zero. In our calculations, there may be points beyond point A where elasticity is infinite, and beyond E, the elasticity may be zero.