Price Elasticity of Demand

Posted: August 13th, 2013

Price Elasticity of Demand

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Abstract

One of the main measures that are constantly used in the fields of economics to determine the effect of the Law of Demand on consumers is the Price Elasticity of Demand. Regardless of the inconsistency that is associated with the measure, the Price Elasticity of Demand is used considerably to determine the effect arising from changes in prices for commodities or services on consumer demand. Consequently, as a computational measure, the Price Elasticity of Demand provides a platform for determining the elasticity and inelasticity of consumer demand with respect to a respective product or service.

Price Elasticity of Demand

Price Elasticity of Demand is a measure that is usually employed in economics to determine the relationship between changes in price and changes in quantity in relation to the Law of Demand. The Price Elasticity of Demand provides the change in the quantity demanded in percentage, in response to a change in price equal to one percent (Taussig, 2007). Usually, the Price Elasticity of Demand is computed by dividing the proportionate change in the demanded quantity by the balanced change in price. The measure is usually in negative values, in order to illustrate the conformity of the prices to the Law of Demand. Alternately, price elasticities that are in positive values represent Ostentatious/Giffen goods or Veblen goods. These commodities do not conform to the Law of Demand (Taussig, 2007; Bowles, 2004).

Question 1

The price of a gallon of paint increases from US$ 3.00 to US$ 3.50 per gallon. The usage of paint drops from 35 gallons to 20 gallons a month. Compute the price elasticity of demand.

Solution

Percentage change in Quantity demanded = (New Quantity-Old Quantity)/Old Quantity

= (20 – 35)/35

= (-15)/35

= -0.4286

Percentage change in Price                         = (New Price – Old Price)/Old Price

= (3.50 – 3.00)/3.00

= (0.50)/3.00

= 0.1667

Therefore, Price Elasticity of Demand = (Percentage Change in Quantity demanded)/ (Percentage change in Price)

= (-0.4286)/ (0.1667)

= -2.571

= 2.571

Question 2

The Price Elasticity of Demand for the change in price is 2.571. The negative is ignored in order to ensure the difference between elasticity and inelasticity of prices based on a scale of 1. As evidently seen, the Price Elasticity of Demand for the paint is greater than 1. This indicates that the demand for the paint is price elastic. Therefore, it is correct to assert that the demand, which is elastic, illustrates that the demand for the commodity is affected by the changes in the commodity’s price.

Question 3

The Price Elasticity of Demand is usually used in economics to determine the sensitivity of a commodity’s demand to a price change. The measure often assumes that other demand determinants such as income, purchasing power of consumers, accessibility to substitutes and other factors are constant in the market. If the price elasticity is high, then consumers are bound to be more sensitive to the changes in price. A high price elasticity of demand illustrates that the moment the price of the specific commodity increases, then consumers will purchase an exceedingly small quantity of the respective product. Alternately, if the price elasticity of demand for the product decreases, then consumers will purchase a considerable amount of the respective product (Perloff, 2004). In addition, low price elasticity for a product illustrates that the change in price has slight control on demand.

In this case, the price elasticity of demand was computed as 2.571. As previously mentioned, it is important to discard the negative sign when assessing price elasticity. Hence, the price elasticity of demand is constantly positive. The commodity, which was paint, possessed a price elasticity of demand of 2.571, which was positive. Additionally, the price elasticity of demand was greater than 1, which enables the economist to assert that the good in question, paint, was price elastic. This means that the commodity possessed demand that was regularly affected by the changes in the prices. Therefore, the demand was very sensitive to the price changes.