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Assignment-6 Principles of Economics QUESTION: Suppose the price elasticity of demand for text books is two and the

price of the text book is increased by 10%. By how much does the quantity demand fall? Inter the result and discuss reasons for the fall in the quantity demand. SOLUTION: Price elasticity of demand (PED) is defined as the responsiveness of the quantity demanded of a good or service to a change in its price. Price Elasticity Demand of

Percentage Change in Quantity Demand for product A Percentage Change in Price for Product A So, Percentage Change in Quantity Demand for Product A = PED X Percentage Change in Price for Product A Given, PED of Books= 2, Percentage Change in Price for Books = 10% So,

Percentage Change in Demand for Books = 2 X 10% = 20% Therefore the fall in the Quantity Demand of the Books will be 20% Price elasticity of demand In other words, it is percentage change in quantity demanded by the percentage change in price of the same commodity. In economics and business studies, the price elasticity of demand is a measure of the sensitivity of quantity demanded to changes in price. It is measured as elasticity, that is, it measures the relationship as the ratio of percentage changes between quantity demanded of a good and changes in its price. In simpler words, demand for a product can be said to be very inelastic if consumers will pay almost any price for the product, and very elastic if consumers will only pay a certain price, or a narrow range of prices, for the product. Inelastic demand means a producer can raise prices without much hurting demand for its product, and elastic demand means that consumers are sensitive to the price at which a product is sold and will not buy it if the price rises by what they consider too much. Drinking water is a good example of a good that has inelastic characteristics in that people will pay anything for it (high or low prices with relatively equivalent quantity demanded), so it is not elastic. On the other hand, demand for sugar is very elastic because as the price of sugar increases, there are many substitutions which consumers may switch to. Value Meaning

Ed = 0 Ed = 1 Ed =

Perfectly inelastic. Unit (or unitary) elastic. Perfectly elastic.

- 1 > Ed > 0 Relatively inelastic. > Ed > 1 Relatively elastic.

A price fall usually results in an increase in the quantity demanded by consumers. The demand for a good isrelatively inelastic when the change in quantity demanded is less than change in price. Goods and services for which no substitutes exist are generally inelastic. Demand for an antibiotic, for example, becomes highly inelastic when it alone can kill an infection resistant to all other antibiotics. Rather than die of an infection, patients will generally be willing to pay whatever is necessary to acquire enough of the antibiotic to kill the infection. Various research methods are used to calculate price elasticity: Test markets Analysis of historical sales data Conjoint analysis

Price elasticity is always negative, although analysts tend to ignore the sign. It is always negative due to the very nature of demand, if the price increases, less is demanded, and thus quantity change is negative, leading to a negative price elasticity of demand. Conversely, if price falls, this negative value will lead to a negative price elasticity of demand value. Determinants Substitutes: The more substitutes, the higher the elasticity, as people can easily

switch from one good to another if a minor price change is made.

Percentage of income: The higher the percentage that the products price is of

the consumers income, the higher the elasticity, as people will be careful with purchasing the good because of its cost.

Necessity: The more necessary a good is, the lower the elasticity, as people will

attempt to buy it no matter the price, such as the case of insulin for those that need it.

Duration: The longer a price change holds, the higher the elasticity, as more and

more people will stop demanding the goods (i.e. if you go to the supermarket and find that blueberries have doubled in price, youll buy it because you need it this time, but next time you wont, unless the price drops back down again)

Breadth of definition: The broader the definition, the lower the elasticity. For

example, Company Xs fried dumplings will have a relatively high elasticity, whereas food in general will have an extremely low elasticity (see Substitutes, Necessity above)