Explain the total outlay method of measuring elasticity of demand?
Solution
The total outlay method is also known as the "Total expenditure method". This method was developed by Prof. Marshall. In this method, the total amount of expenditure before and after the price change is compared.
Here the total expenditure refers to the product of price and quantity demanded.
Total expenditure = Price × Quantity demanded
In this connection, Marshall has given the following propositions:
- Relatively elastic demand (Ed > 1): When with a given change in the price of a commodity total outlay increases, the elasticity of demand is greater than one.
- Unitary elastic demand (Ed = 1): When the price falls or rises, the total outlay does not change or remains constant, the elasticity of demand is equal to one.
- Relatively inelastic demand (Ed < 1): When with a given change in the price of a commodity total outlay decreases, the elasticity of demand is less than one.
This can be explained with the help of the following example.
Total outlay method
Price in ₹ (P) | Quantity demanded in units (Q) | Total outlay (P × Q) | Elasticity of demand | |
A | 10 | 6 | 60 | Ed > 1 |
20 | 5 | 100 | ||
B | 30 | 4 | 120 | Ed = 1 |
40 | 3 | 120 | ||
C | 50 | 2 | 100 | Ed < 1 |
0 | 1 | 60 |
In the above table example ‘A’ original price is ₹ 10 per unit and the quantity demanded is 6 units. Therefore, total expenditure incurred is ₹ 60. When price rises to ₹ 20 quantity demanded fall to 5 units, the total expenditure incurred is ₹ 100. In this case, total outlay is greater than the original expenditure. Hence, in this example elasticity of demand is greater than one. (Ed > 1) that is relatively elastic demand.
An example ‘B’, original price is ₹ 30 per unit and the quantity demanded is 4 units. Therefore total expenditure is ₹ 120. When the price rises to ₹ 40 quantity demanded fall to ‘3’ units. Total expenditure incurred is ₹ 120. In this case, the total outlay is the same (equal) as the original expenditure. Hence, in this example, elasticity of demand is equal to one (Ed = 1) which is unitary elastic demand.
An example ‘C’, original price is ₹ per unit and the quantity demanded is 2 units. Therefore the total expenditure is ₹ 100. When price rises to ₹ 60, quantity demand falls to 1 unit and total expenditure incurred is ` 60. In this case, the total outlay is less than the original expenditure. Hence, elasticity of demand is less than one (Ed < 1) that is relatively inelastic demand.