Price elasticity of demand measures the sensitivity of quantity demanded of a commodity to a unit change in the price of the commodity holding other factors affecting demand constantly. An increase in the price of commodity results in a decline in quantity demanded. A commodity has a perfectly inelastic demand curve when the price elasticity of demand equals zero. For inelastic demand, the price elasticity lies between zero and one. Elastic demand has an elasticity that lies between one and infinity.
The price elasticity of demand for electricity for both residential and industrial users lies between zero and one (0 < PED < 1). This implies that demand by the two groups of users is inelastic. However, the two groups of users have a different degree of inelasticity. The price elasticity of demand of elasticity for residential users is -0.65 and -0.45 for industrial users. This implies that the demand for electricity by industrial users is less elastic than demand by residential users because a change in the price of electricity by one unit results in to change in quantity demanded by lesser units (0.45) than that of residential users (0.65). Graph 1.0 shows the demand curve for the two groups of users and the effect of price increases in the quantity demanded.
From the graph, assume that the price of electricity increases from P1 to P2, the quantity demanded by residential users will decrease by area B while industrial users will decrease by area A. Area B is greater than area A because the demand for electricity by residential users is more elastic than the demand by industrial users.
Effect of price increase on the quantity demanded
The general law of demand stipulates that an increase in the price of commodity results in a decline in quantity demanded holding other factors constant. Since the demand for the commodity is inelastic, an increase in price by 15% leads to a decline in quantity demanded by less than 15%.
For residential users
Elasticity of demand = (DQ * P) / (DP * Q) = 0.65
The quantity demanded for electricity will decrease by 0.15 * 0.65 = 9.75%.
For Industrial users
Elasticity of demand = (DQ * P) / (DP * Q) = 0.45
The quantity demanded electricity will decrease by 0.15/0.45 = 6.75%.
From the calculations, it is apparent that an increase in price by 15% results in a decline in demand for both users. Demand for electricity for residential users declines by 9.75% while that for industrial users declines by 6.75%. It is attributed to the fact that industrial users are less sensitive to price changes thus the lowest decline in quantity demanded than residential users as shown in graph 1.0.
The effect of power being consumed without paying the power charges on the elasticity of demand
Electricity is a public good in China since it is provided by state-run companies. For public commodities, once the state has provided the good, everyone can enjoy the use of the commodity including the people who do not pay for the commodity. The problem is commonly known as the “free-rider problem”. This group of citizens experiences a perfectly inelastic demand curve, that is, a change in price does not affect the quantity they demand. The combined demand curve for the public good is obtained by adding up the price each individual is willing to pay. If 20% of electricity is consumed without paying the power charges, then the elasticity of demand for electricity in China will be more inelastic than it is now.