Microeconomics

Posted: October 17th, 2013

Microeconomics

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Microeconomics

The price elasticity of demand refers to a measure of sensitivity of the amount of a product demanded to changes in price. The price elasticity of demand is deemed inelastic when the demand of the commodity fails to exhibit much response to changes in the commodity’s price. Mathematically, the price elasticity of demand is calculated using the following expression:

P.E.D. = (Percentage Change in Quantity Demanded) / (Percentage Change in Price). Using the expression above, the price elasticity of demand for the laptop is 2, whereas that of cigarettes was 0.5. In addition, the price elasticity of water is Zero. Although all figures have negative values except for water, the negative is ignored since only the absolute values are required. It is therefore evident that the laptop is more elastic than the other products (Zikmund, 2010).

The price elasticity of demand is of benefit to the market in various ways. Company managers and administrators are able to recognize how the change in price, in a given product, will affect the accumulated revenue and expenditure on the given product. Managers are also to forecast the probable price changes in the market when there are changes in supply. This is especially beneficial to businesspersons and producers dealing in products that suffer high price changes over a given period.

Most governments will often adjust the indirect tax upwards. When this happens, businessmen can use the price elasticity to deliberate on whether to pass on some or all of the tax expenditure to the consumer. Analyzing the figures will indicate whether the business is likely to a high decrease in profit when it absorbs the increased government tax, or when it passes on part or entire expense to the consumer. This is because different price increments will have different effects on the quantity of the product demanded.

Price elasticity is also highly essential in price discrimination. Price discrimination is mainly undertaken by a monopoly supplier. In this case, the supplier will often set the prices of products at varying levels in different segments of the market. For instance, monopolistic transport companies and communication companies will often set varying prices depending on whether it is peak time or off-peak.

The price elasticity of demand is affected by various factors in the market. The availability of substitutes for a given product will significantly affect the price elasticity of demand. When there are more possible substitutes for a given product in the market, the elasticity is bound to increase. On this note, the amount of substitutes for a given product is determined by how broad the commodity is defined. Price elasticity of demand is also determined by the degree of necessity or luxury.

Basic commodities are bound to have minimal elasticity, as opposed to luxury products. This is mainly because consumers can hardly live without necessities such as water and electricity while, on the other hand, can easily forego luxuries such as expensive vacations depending on prices in the market. On the other hand, there are those commodities having an initial, minimal degree of necessity but are habit forming. This means that, after successive consumption, such commodities end up becoming necessities to some consumers (Stanwick, & Stanwick, 2009).

The proportion of the consumer’s budget taken up by the product also affects the price elasticity of demand for the given commodity. Expensive commodities that take a larger fraction of the consumer’s budget, exhibit higher elasticities. Time, on the other hand, plays a role in influencing price elasticity in that, consumers later adjust their behavior in accordance with the market prices and thus rendering commodities to have a greater elasticity.

Volatile market changes in price where the prices increase and decrease within given day will have a different effect in comparison to when the change is permanent. On the other hand, differences in price points also tend to elicit different responses in the price elasticity of demand. For instance, decreasing the price of a commodity from $2.00 to $1.99 will elicit a different response in comparison with decreasing it from $1.99 to $1.98. The initial price decrease is bound to invoke higher price elasticity in comparison with the latter irrespective of the fact that both have equal price decrements (Pride, Hughes, & Kapoor, 1999).

The price elasticity of supply refers to how the quantity of a commodity supplied responds to changes in market prices. It is the percentage change in the amount of the commodity supplied in response to a percentage change in price. This figure is entirely focused on the supply side of the market. Mathematically, the price elasticity of supply is calculated using the following expression:

P.E.S. = (percentage Change in Quantity Supplied) / (percentage Change in Price). When the price of elasticity obtained from the above expression is greater than one, then the supply is deemed price elastic and thus responds to changes in price. When the figure is equal to one, then the supply is deemed as unit elastic, and when the figure falls below one, the supply is price inelastic meaning that it does not respond to changes in price (Marcoux, 1999).

From the information given, the P.E.S. of hotel room = 10/20 = 0.5. The P.E.S. of health care is given by: 50/50 = 1. The P.E.S. of a book is given by: 20/10 = 2. The book is deemed more elastic in comparison with the others because its resultant is greater than one. This means that the supply of the book is highly sensitive to price changes. The least elastic commodity is the hotel room as its resultant is less than one, meaning that the commodity’s supply is not sensitive to price changes.

Beachfront properties, gourmet coffee, luxury automobiles, cell phones would tend to exhibit high price elasticity in demand mainly because they are classified as luxuries. This means that consumers will readily do without such when there is an increase in their prices. Bridge tolls, gasoline, computers and college tuition will exhibit relatively low price elasticity in demand since they are basic commodities. Bridge tolls, gasoline and gourmet coffee, are likely to exhibit inelastic price elasticity of supply.

This is mainly because they are constant and thus the producers may lack the capacity to increase supply in response to the increase in prices. However, college tuition, computers, cell phones, and luxury automobiles are bound to exhibit elastic price elasticity in supply since the suppliers have the capacity to increase supply in response to an increase in market prices (Davies, 2010).

The best time to increase commodity prices is when there is a high positive value in the income elasticity of demand. Changes in real national income are usually recurrent. Demand usually increases when the economy is expanding but tends to decrease when it is slowing down. As indicated in the diagram below.

The flower business is termed as a luxury market and thus exhibits inelastic price elasticity of demand. However, there are certain times of the year such as valentines and other holidays when the commodity’s demands increases. At such times, it is advisable for one to increase the price to maximize profits.

References

Davies, R. (2010). Fifth business. New York: Viking Press.

Marcoux, H. L. (1999). Business correspondence, principles and practice. New York: D. Van Nostrand company, inc.

Pride, W. M., Hughes, R. J., & Kapoor, J. R. (1999). Business. Boston: Houghton Mifflin Co.

Stanwick, P. A., & Stanwick, S. D. (2009). Understanding business ethics. Upper Saddle River, NJ: Pearson Prentice Hall.

Zikmund, W. G. (2010). Business research methods. Mason, OH: South-Western Cengage Learning.