Sunday, February 5, 2017

Total expenditure method of measuring Elasticity of Demand

Total Expenditure Method
The name of Dr. Marshall is associated with this method. This method is also known as Total Expenditure Method Total Revenue Method. In this method, statistics of total expenditure is used to find out elasticity of demand. Total expenditure at the original price and total expenditure at the new price is compared with each other, and we come to know the elasticity of demand.

When price falls or rises, total expenditure does not change or remains constant, demand is unitary elastic.

When price falls, total expenditure increases or price rises and total expenditure decreases, demand is elastic or elasticity of demand is greater than one.      
  
When price falls and total expenditure decreases or price rises and total expenditure increases, demand is inelastic or elasticity of demand is less than one. Measurement of elasticity of demand with the help of total, expenditure method can be better understood with the help of the following example.

Total Expenditure Method

Price (Rs.)
Demand (Units)
Total Outlay (Rs.)
Elasticity of Demand
A
10
8
12
15
120
120
Unitary or 1
B
10
8
12
20
120
160
Elastic or > 1
C
10
8
12
14
120
112
Inelastic or < 2


In example A, original price is Rs. 10 per unit and demand is 12 units. Therefore total expenditure incurred is Rs. 120/-. Price falls to the level of Rs. 8/- and demand rises up to15 units. But total expenditure is still Rs. 120/-. In this case, total outlay does not change even though there is change in price. Therefore, demand is unitary elastic.

In example B, at the price Rs. 10/-, 12 units are demanded. So total original expenditure is Rs. 120/-. Price falls to Rs. 8/- per unit and demand rises to the level of 20 units. Therefore, total expenditure incurred on commodity rises to Rs. 160/-. Total expenditure under this new condition of change in price, is greater than original expenditure. Hence, in this example, demand is elastic or elasticity of demand is greater than one.

         In example C, original total outlay is Rs. 120/- with a change in price to Rs. 8/- per unit, demand expands to the extent of 14 units. Nevertheless, total expenditure Rs. 112/-, which is less than original expenditure. Therefore, in this example demand tends to be inelastic or elasticity of demand is less than one.