Microeconomics for business/Price Elasticity of Demand/Solution to Mathematical Problems
Elasticity of Demand
The concept of elasticity
of demand was introduced by economists like Cournot, J.S. Mill, etc. However,
the application of it in economics was popularized by Alfred Marshall. The law
of demand is only able to show the direction of change of demand and its
determinants, whereas elasticity of demand can explain both direction and
magnitude of change in demand and its determinants.
In economics, the demand
elasticity (elasticity of demand) refers to how sensitive the demand for a good
is to changes in determinants of demand, such as prices, consumer income,
prices of related goods, advertisement, and so on. Demand elasticity is
calculated as the percent change in the quantity demanded divided by a percent
change in another economic variable (determinants of demand). Higher
demand elasticity for an economic variable means that consumers are more
responsive to changes in this variable.
There are as many types of elasticity of demand as there are types of economic variables
determining the demand. However, there are four main types of elasticity of
demand namely; Price elasticity of demand, Income elasticity of demand, Cross
elasticity of demand, and advertisement elasticity of demand.
Price Elasticity of Demand
Among these types, the price
elasticity of demand is the most important one. Price elasticity of demand is
the degree of how much the quantity demanded of a commodity varies when its
price changes, other things remaining the same.
Precisely saying, the price elasticity of demand measures the ratio of the percentage change in the quantity demanded of a commodity to a percentage change in the price of that commodity.
Precisely saying, the price elasticity of demand measures the ratio of the percentage change in the quantity demanded of a commodity to a percentage change in the price of that commodity.
As we know that the theory
of demand specifies only a route of alteration in quantity needed in response
to a change in price. This does not tell us by how much or to what level the quantity demanded will be affected or changed with the change in its price.
This information as to how much or to what extent the quantity demanded of a commodity will change as a result of the change in price is provided by the concept of price elasticity of demand. So, this concept has a significant role in economic literature and in business decision making.
Only the nature and direction of a relationship between various economic variables can not establish and provide guidance for the application of the law of demand and supply for making pricing decisions by the business firms and for the government to formulate its pricing and taxation policies in the areas like; price determination of public utilities, fixing prices of essential goods, food grains and medicines, determination of the rate of commodity taxes, and determination of export and import duties.
This information as to how much or to what extent the quantity demanded of a commodity will change as a result of the change in price is provided by the concept of price elasticity of demand. So, this concept has a significant role in economic literature and in business decision making.
Only the nature and direction of a relationship between various economic variables can not establish and provide guidance for the application of the law of demand and supply for making pricing decisions by the business firms and for the government to formulate its pricing and taxation policies in the areas like; price determination of public utilities, fixing prices of essential goods, food grains and medicines, determination of the rate of commodity taxes, and determination of export and import duties.
Thus, price elasticity of demand is the responsiveness of demand for a
commodity divided by the percentage change in the price. that is,
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| The formula of Price Elasticity of Demand |
Here, the elasticity of demand is denoted by Ep. The arithmetic value of Ep is known as the coefficient of price the elasticity of demand. The general formula for measuring the price elasticity of
demand is derived as;
Here, Q1 is initial demand, Q2 is demand after the price change, P1 is the original price, and P2 is the changed price. Q2-
Q1 denotes the change in quantity
demanded and noted by DQ and P2-
P1 denotes the change in the price of the
commodity and noted by DP Replacing the notation in the above expression we get,
Uses of Price Elasticity of Demand
The concept of price
elasticity is of great practical importance in the formulation and understanding
of economic policies and problems. In business decision making, price
elasticity is applicable directly and indirectly.
The businessman must know the effect of the price change on quantity demanded of the product and factors in the market and such can be gained from the concept of price elasticity. Thus, from consumers to the government the concept of price elasticity is useful in different stages. The application of the concept of price elasticity of demand in commercial decision making can be pointed as below:
The businessman must know the effect of the price change on quantity demanded of the product and factors in the market and such can be gained from the concept of price elasticity. Thus, from consumers to the government the concept of price elasticity is useful in different stages. The application of the concept of price elasticity of demand in commercial decision making can be pointed as below:
Determination of price policy
While fixing the price
of any product, a businessman has to consider the elasticity of demand for the
product. He should consider whether a lowering of the price will stimulate demand
for his product, and if so to what extent and whether his profits will also
increase a result thereof. If the demand for the product is elastic, business
may earn more revenue by setting the lower price and if the elasticity is less, one
can set the higher price of the product.
Price discrimination
Price discrimination
refers to the act of selling the technically same products at different prices
to different sections of consumers or in different sub-markets. In the market
with elastic demand for the product, the discriminating monopolist fixes low
price and in the market with less elastic demand, he charges a high price.
Pricing of public utilities
The concept of price elasticity
of demand further helps in fixing the prices for the services rendered by
public utilities. If the demand is inelastic, a high price can be charged and
in case of elastic demand, a lower price should be charged.
Pricing of joint product
For the pricing of
joints products like wool and mutton, paddy and straw, chicken, and eggs, the concept of price elasticity of demand is needed. In the case of joint product, the measurement
of separate cost of the production of each commodity sometimes may not be possible
and in such case, the pricing of these products could be fixed by the elasticity of
demand.
Demand forecasting
Given the elasticity of
demand and the state of an independent variable, it is always possible to forecast
the demand for a particular good.
Importance in International trade
The concept of price elasticity of demand is very useful in order to fix the term and conditions of
multinational trade and commerce. The countries can get benefit from
international trade with the help of the concept of price elasticity of demand.
When the nation exports those goods whose elasticity of demand in the foreign market is high then the price must be competitive and low and if the product of internal the market has inelastic demand in the foreign market then price should be higher and thereby countries can get benefits from their foreign trade.
When the nation exports those goods whose elasticity of demand in the foreign market is high then the price must be competitive and low and if the product of internal the market has inelastic demand in the foreign market then price should be higher and thereby countries can get benefits from their foreign trade.
Helps in taxation policy formulation
Government can impose
higher rate of taxes on those goods which have inelastic demand in the market
and lower taxes on goods having higher elasticity in the consumer market. The demand
of those products having inelastic demand will not be affected more by imposing
high taxes by the authority and this will ensure more tax revenue to the
government.
On another side, the lower tax rate should be charged in those products which have elastic demand in the market to generate more revenue from taxes.
On another side, the lower tax rate should be charged in those products which have elastic demand in the market to generate more revenue from taxes.
Mathematical Calculation of Price Elasticity of
Demand/Solution to Mathematical Problems of Price Elasticity of Demand
In the market, different
products show different types of responses to the price. It means goods are
available in greater variation in terms of elasticity of demand. Some goods are
of those types whose demand is not highly affected by changes in prices like
salt, medicine, wheat, rice, and so on.
But we have also different products whose demand is highly fluctuated with the change in their prices. For example, the demand for products like laptops, computers, television, is highly affected when there is a change in their price. so the goods whose demand is highly affected are called elastic one and non-affecting are called inelastic products.
Price could be high in case of less elastic or inelastic goods but the price should be less in case of elastic goods. So, to know the nature of goods and their capability to satisfy human wants, the measurement of price elasticity demand is essential. It has occupied a significant role in the study of microeconomic theories and behaviors in theory as well as practice.
But we have also different products whose demand is highly fluctuated with the change in their prices. For example, the demand for products like laptops, computers, television, is highly affected when there is a change in their price. so the goods whose demand is highly affected are called elastic one and non-affecting are called inelastic products.
Price could be high in case of less elastic or inelastic goods but the price should be less in case of elastic goods. So, to know the nature of goods and their capability to satisfy human wants, the measurement of price elasticity demand is essential. It has occupied a significant role in the study of microeconomic theories and behaviors in theory as well as practice.
Here you can
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solution to all the possible problems from the topic price elasticity of
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