- The price elasticity of demand - Free Essays on Economics The price elasticity of demand
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## The price elasticity of demand

The determinants of price elasticity of supply are the existence of stocks. In fact, price elasticity of supply depends on the size of production of a firm supplying the market. Where firm have small or no flexibility to adjust output, supply is said to be inelastic. For example, if the stocks kept will make the supply elastic, as the stocks can be easily released to the market to rise supply. This means that stocks that able to store easily will likely to have an elastic supply however for those stocks that cannot be stored like fresh cake and fresh flowers, supply is said to be inelastic. Another important determinant of price elasticity of supply is time period. Supply will be more elastic when it is given a longer time period because producers are given the opportunity to increase the capacity of their operation and easier to increase supply. For example, a production of breads and cakes can vary daily so that bakers able to take action in a short time period to the changes in price.

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## PART B

Business uses the concept price elasticity to decide on their pricing strategy by measure the elasticity of the business, which can be apply to either demand or supply. The price elasticity of demand shows the proportional change in the quantity demanded as a ratio of the proportional change in the item’s price. There is an inverse relationship between price and the quantity demand. If the business rises the price of a product up, other factors remain unchanged, the sales of a product will fall, while if the price is decrease, the sales of a product will increase. However, a business can be decides the pricing strategy by knowing the sensitivity of the demand for its product to changes in price. The price elasticity of demand can be measured by using the formula, percentage change in quantity demanded divide by percentage change in price. If the value for price elasticity of demand is larger than one, the demand is said to be price elastic, as the product change in price will cause a significant change in quantity demand. For example, toothpaste and chocolate biscuits. If the price of toothpaste were rise or fall by 50 cent, it would not result to be a very big change in the demand for toothpaste. However, if the price of chocolate biscuits were rise or fall by 50 cent, it might affect the change in the quantity because consumer would buy other kind of biscuits. Therefore, it is important for a business decide on their price of a product in order to have a maximum profits, especially the product is tend to be elastic. From the example above, the toothpaste is said to be inelastic because the demand for toothpaste does not affected much by a change in prices. The demand is also say to be inelastic when the value for price elasticity is greater than one. Business uses the concept of elasticity of demand to determine the best pricing strategy for a firm and make a decision whether to changes prices. If the demand is elastic, the business lower the price of the product would increase the sales, thus increasing total profit. If the demand is inelastic, the firm could rise the prices up which the total revenue also increase.

## PART A

According to the law of supply states that as the price of products rise, the quantity supplied of the products increase and provided other factors remain unchanged because at the higher price of a product, firms will discover that the production and sale of the product is more profitable. Other than that, it encourages more firms enter the market and produce more goods. However, price of other goods might affect the supply of a product increase. If the price of other good rises, the quantity supply of a good increase. At this time, a firm might find a higher profit to transfer the production to other good, causing the supply of original good to decrease even though its price remain unchanged. For example, an increase in the price of beef will lead to a higher quantity of beef supplied. At the same time, more leather will be produced, even if the price of the leather had not changed. Another reason that causes supply of a product increases is the price of raw material. It will affect the profitability if the prices of raw material decreases, the production cost will also decrease and more firms are willing to supply the product, thus the supply will rise.

## PART B

When economists say that “price floors and ceilings stifle that rationing function of prices and distort resource allocation” mean when in the free-market system, it results in unfairness in income and wealth, with the cause that everyone has difference influence on how resources are used. Government decides to set a maximum and minimum price to control on the market, which is price floor and price ceiling. The reason of the price

floor and price ceiling that impose by the government is to prevent these imbalances corrected by price movement. For example, sellers will find themselves that output at a given price is more than consumers are willing to buy, the price will decrease. Similarly, if the consumer demand is not satisfy by insufficient of good, the price will increase. A price floor prevents the market price from decrease to equilibrium level. It is in result a minimum price, that’s why it is call price floor. A government imposes a price floor because it thinks the equilibrium price is too low. When a price is set greater than equilibrium price, more suppliers are now willing to produce the product so that they can sold it for a higher price. This price floor that set by government is to ensure producer minimum income. In the other hand, a price ceiling is set below equilibrium price and to prevent inflation happens in the market. The price ceiling most probable to be necessity product. The maximum price that set by government is to unsure the poorer people still afford to buy the product.

## PART A

According to the law of demand states that demand is varies inversely with price of a good. This means when the price of a good rises, the demand of a good will falls and provided other factors remain unchanged this is because at different price level, consumer are not longer can afford the goods. Somehow, there is some difference between a decrease in demand and decrease in quantity demanded. There is several determinants that will affect in demand are the prices of others good, taste and fashion, expectation, the size of household income and so on. The demand curve will shift leftward when a decrease in demand. Price (\$)

D1 D0

Quantity per period

Quantity of Nokia MP3 demanded

## Figure 5 (a) A shift in demand

For example, usually when consumer income increased, demand of a good will also increased. In a special case, the consumer income increase, the demand of a good will falls. In the figure 5(a) shows at the price P1, the quantity demand of a good falls from D0 to D1. This is because of the consumer will change their preference toward superior 5

good. A decrease of a good in figure 5(a) is inferior good. A change in demand curve can be affected by many determinants however there is only one factor that causes a decrease in quantity demand that is the price of the goods itself.

## Figure 5(b) A movement in demand

For example, based on the figure 5b, at a price increase from \$4 to \$5 causes the quantity demand to decrease from 100 to 60 units. This change in price does not cause the original demand curve to shift. However, it is a movement from point A to point B on the same quantity demand curve.

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## PART B

The income elasticity of demand measure the responsiveness of percentage change in quantity demand respect to the percentage change in income. The value of income elasticity of demand can be measure by formula which is percentage change in quantity demand divide by percentage change in income. If the value of income elasticity of demand shows a positive value, this shows a positive relationship between income and demand. As the income of household increases, the demand of a good also increases.

It can be divided into 2 types, income elastic and income inelastic. If the value of income elasticity of demand is between zero and one, the demand is say to be inelastic. For instance, as the consumer income rises, consumer will demand more clothes, thus indicating the item is a normal good. At the same time, if the value of income elasticity of demand is greater than one, the demand is elastic. For instance, as the price of a branded watches rises, the demand for branded watches also rise because the consumer wanted to “show off “the luxury good. As if the price of a good decreased and everyone can afford to buy the good, the item is said to be no value to “show off”. Thus, through the income elasticity of demand it can shows the living standards and consumer spending patterns when the income rises. However, some products show the income elasticity of demand value is negative which is smaller than zero. There is a negative relationship between consumer income and demand of a good, the means a rises in income will leads to a decrease in demand. This explains that as their income increase, the household will change their preference towards better goods instead of the “inferior” products. These goods are called inferior goods. In the other case, some the value of income elasticity of demand is exactly zero. The good is a necessity good because the quantity demanded of the good does not change as income changes. For instance, as the price of the rice rises, people will reduce to buy meat and fish so that they able to continue buy enough rice to say alive. Examples of necessity good are salt, toothpaste, shampoo and so on.

Consider the demand curve in figure 6 (a). It shows that at 50 cents, the consumer will purchased five units. When the price is greater than 50 cents, the consumer will buy not more than five units. Thus, 50 cents is maximum price, the consumer will pay for five units. However, the demand curve also shows that consumer is willing to pay more than 50 cents for each of the first four units consumed. The fact that the consumer is charged 50 cents for each unit purchased suggest that the first four units are a bargain. Consumer refers to the difference between the total amount which consumer are prepared to pay for their purchases of a product and the total amount they actually pay. In the figure above, consumer surplus is the shaded area below the demand curve and enclosed by horizontal line at 50 cents and vertical axis.

## Figure 6(b) Producer surplus

In the figure 6b, the supply curve shows that at 30 cent is the actual price that received. If the price is less than 70 cents, the consumer will supply less than 500 units. Hence, 70 cents is the highest price that producer will sell for 500 units. However, the supply curve also shows the producer is prepared to sell higher than 30 cents for each of the units. The term producer surplus refers to the difference between the prices producers actually receive over the price they are willing to receive. In the case of the supply curve in figure 6b, producer surplus is the shaded area above the curve and bound by the horizontal line at 70 cents and vertical axis.

## PART B

The three basic economic concepts are scarcity, choice and opportunity cost. Scarcity is a common economy problem in all economies. This scarcity of resources is refers to the land, labour and capital. Hence, the scarcity is illustrated by using the production possibilities frontier as shown in graph 6 ©.

## Figure 6 C

The scarcity is represent by point C, which is outside the frontier is called unattainable points. There is impossible produce product at point C with the economy’s limited resources and technology.The choice are made due to the implication of economic problem. As a consumer need to choose because of the limited factors does not allow to buy all the wants. In each case, choosing one option means that another option are forgone. However, the cost of these forgone alternative can measure by an economic activity. Opportunity cost states the cost of using resources in terms of the best of the alternative uses of those resources. For example, the opportunity cost of Alice attending university full time is the wage that she forgoing by not having a full-time job. If the full time job able to earn \$ 20 000 per year and Alice are studying a three year course. The opportunity cost of doing the course is at least \$60 000. We can also illustrate the

concept of opportunity cost as shown in figure below. In figure below, there is only one alternative uses of resources are in the production of agriculture and manufacture because the curve shows a maximum production combination, to produce more of a product in economy is to decrease production of the other. The point that lied on the curve is efficient points that produce that maximum output.

For instance, to increase the production of manufactures from S to W units, production of a agriculture must fall from Y to Z units. Thus, the opportunity cost of the extra units of manufactures is the reduce production of agriculture.

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