Economics Essay Sample Elasticity of Demand
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Elasticity of demand
Elasticity of demand refers to measurement to the change in responsiveness to the demand of the commodity because of change in factors like price and other economic variables. It is important to comment here that the demand of the commodity is not only responsive to the price of the good but also other factors like price of substitutes, income of consumer etc. The concept carries great significance as it helps the firms in modeling the potential change in the demand of the good because of various factors thus guiding the firms towards more optimal competitive behavior. Below discussed are three elasticities of the demand followed by factors that affect price elasticity:
-Price elasticity of demand
This measure of elasticity measures the change in the quantity demanded of the goods or services because of change in the related market price. Below is the formula for calculating the price elasticity of demand:
Ep= % change in the quantity demanded/ % change in the price of the good
Varying degrees of price elasticity of demand
i) Unitary Elastic: If the % change in the quantity demand is similar to the % change in the price of the good, in that case, demand is said to be unitary elastic. Mathematically, it is represented as Ep= 1
ii) Greater than unitary elastic: If the % change in the quantity demanded is greater than the % change in the price of the good, in that case, demand is said to be greater than unitary elastic. Mathematically, it is represented as Ep>1.
iii) Less than unitary elastic: If the % change in the quantity demanded is less than the % change in the price of the good, in that case, demand is said to be less than unitary elastic. Mathematically, it is represented as Ep<1.
iv) Perfectly inelastic: If the change in the price of the good brings no change in the quantity demand of the good, in that case demand is said to be perfectly inelastic. Mathematically, it is represented as Ep= 0.
v) Perfectly elastic: If the change in the price of the good brings an infinite change in the demand of the good, in that case, demand is said to be perfectly elastic. Mathematically, it is represented as Ep= ∞.
-Cross Elasticity of demand
Since the demand of a product is also influenced by factors other than price, such as price of related goods, the elasticity is then measured through the metric of cross elasticity of demand. This measure of elasticity of demand measures the change in the demand for a good in response to the change in the price of a substitute or complimentary goods. The formula for calculating the cross elasticity of demand is:
Cross elasticity of demand= % change in the quantity demanded/ % change in the price of substitutes or complimentary goods
It is important to note that cross elasticity of demand is always positive for substitute goods (tea and coffee) and negative for complimentary goods (bread and butter)
Apart from price of good and the price of related goods, demand is also sensitive to the income of the consumer which is measured using the metric of income elasticity of good. The formula for measuring income elasticity of demand is:
Income elasticity of demand: % change in the demand/ % change in the income
It is important to note that while normal goods always have positive income elasticity, inferior goods indicates negative income elasticity.
Demand Elasticity. n.d. 2 March 2015 <http://www.investopedia.com/terms/d/demand-elasticity.asp>.
Kaplan. "Elasticity." Kaplan. Schweser Notes for CFA Exam- Economics. USA: Kaplan Inc, 2010. 12-18.
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