Price Elasticity Of Demand example essay topic

Elasticity is the concept in economics that measures the responsiveness of one variable in response to another variable. The best measure of this responsiveness is the proportional or percent change in the variables. This gives the most usable results for any type or range of data. Thus, elasticity is the proportional (or percent) change in one variable relative to the proportional change in another variable. The general formula for elasticity is: E = Percent change in x Percent change in y An important characteristic of demand is the relationship among market price, quantity demand and consumer expenditure. The nature of demand is such that a reduction in market price will usually lead to an increase in quantity demanded.

Given that consumer expenditure is the product of these two variables, the effect of a price reduction will have an uncertain impact on this expenditure. In some cases a reduction in price will be more than offset by a large increase in quantity demanded -- a situation where demand is price sensitive or price elastic. The price elasticity of demand measures the responsiveness of quantity demanded to a change in price, with all other factors held constant. The price elasticity of demand, Ed is defined as the magnitude of: = Proportionate change in quantity demanded proportionate change in price Arc PED = Q 2 "C Q 1 x P 1 + P 2 P 2 - P 1 Q 1 + Q 2 Point PED = Q 2 "C Q 1 x P P 2 - P 1 Q These are some example of leads to a 30% increase in quantity demanded, the price if the PED is greater than one, the good is price elastic. Demand is responsive to a change in price. If for example a 15% fall in price e elasticity = 2.0 If the PED is less than one, the good is inelastic.

Demand is not very responsive to changes in price. If for example a 20% increase in price leads to a 5% fall in quantity demanded, the price elasticity = 0.25 If the PED is equal to one, the good has unit elasticity. The percentage change in quantity demanded is equal to the percentage change in price. Demand changes proportionately to a price change. If the PED is equal to zero, the good is perfectly inelastic. A change in price will have no influence on quantity demanded.

The demand curve for such a product will be vertical. If the PED is infinity, the good is perfectly elastic. Any change in price will see quantity demanded fall to zero. This demand curve is associated with firms operating in perfectly competitive markets A relatively elastic demand curve A relatively inelastic demand curve The Cross-price elasticity responsiveness of demand for good X following changes in the price of a related good Y. The main use of cross price elasticity concerns changes in the prices of substitutes and complements. For example, an increase in the price of private motoring might cause a change in the market demand for mass (public) transport. Here the prices of two substitutes have changed.

Another example is a fall in the price of low cost domestic airfares, leading to an increase in the demand for taxi journeys from airports. In this situation, we see the effect of a change in the price of two complements. Sometimes the price of one good will shift the demand for another good. For example, an increase in the price of chicken will increase the demand for pork. We measure this response by the cross-elasticity of demand: Ec = % ^ Qty dd a = Qa 2 "C Qa 1 x Pb 1 + Pb 2%^ Price b Pb 2 + Pb 1 Qa 1 "C Qa 2 For example, suppose the price of chicken goes up by 10% and as a result the quantity Demanded of pork increases by 2%, with no change in the price of pork or anything else That would influence the demand for pork. Then the cross-elasticity of demand for pork, with respect to the price of chicken, is 2% = 0.2.

10% If the cross elasticity is positive, it means that an increase in the price of one good will increase the demand for the other good. When we observe a positive cross-elasticity, we say that the two goods are substitutes, as with chicken and pork. Conversely, butter and margarine are substitutes, so we would expect their cross-elasticity is to be positive. If the cross-elasticity of demand is negative, that means that an increase in the price of one good cuts the demand for the other. For example, if the price of bicycles went up, we would expect to see a decline in the demand for bike helmets. In this sort of case, we say the goods are complements.

Income elasticity of demand measures the responsiveness of demand to a change in the real incomes of consumers. The formula of income elasticity is: Ey = %^ in Q = Q 2 "C Q 1 x Y 1 + Y 2%^ in Y Y 2 "C Y 1 Q 1 + Q 2 The value of income elasticity of demand depends on the nature of the good or service. Luxury goods have an income elasticity of demand greater than one. Inferior goods have negative income elasticity.

See inferior goods, luxury goods, and normal necessity goods. Normal goods have a positive income elasticity of demand so as income rise more is demand at each price level. We make a distinction between normal necessities and normal luxuries (both have a positive coefficient of income elasticity). Many luxury goods also deserve the sobriquet of! ^0 positional goods! +/-.

These are products where the consumer derives satisfaction (and utility) not just from consuming the good or service itself, but also from being seen to be a consumer by others. Necessities have an income elasticity of demand of between 0 and +1. Demand rises with income, but less than proportionately. Luxuries on the other hand are said to have an income elasticity of demand +1. (Demand rises more than proportionate to a change in income).

Inferior goods have a negative income elasticity of demand. Demand falls as income rises. In a recession, the demand for inferior products might actually grow (depending on the severity of any change in income and also the absolute co-efficient of income elasticity of demand). For example if we find that the income elasticity of demand for cigarettes is -0.3, then a 5% fall in the average real incomes of consumers might lead to a 1.5% fall in the total demand for cigarettes (ceteris paribus). Below is the example of income elasticity graph. Factors that determine the value of price elasticity of demand Number of close substitutes within the market - The more (and closer) substitutes available in the market the more elastic demand will be in response to a change in price.

In this case, the substitution effect will be quite strong. Luxuries and necessities - Necessities tend to have a more inelastic demand curve, whereas luxury goods and services tend to be more elastic. For example, the demand for opera tickets is more elastic than the demand for urban rail travel. The demand for vacation air travel is more elastic than the demand for business air travel.

Percentage of income spent on a good - It may be the case that the smaller the proportion of income spent taken up with purchasing the good or service the more inelastic demand will be. Habit-forming goods - Goods such as cigarettes and drugs tend to be inelastic in demand. Preferences are such that habitual consumers of certain products become de-sensitized to price changes. Time under consideration - Demand tends to be more elastic in the long run rather than in the short run. For example, after the two world oil price shocks of the 1970's - the "response" to higher oil prices was modest in the immediate period after price increases, but as time passed, people found ways to consume less petroleum and other oil products. This included measures to get better mileage from their cars; higher spending on insulation in homes and car-pooling for commuters.

The demand for oil became more elastic in the long run. LIST OF

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