Economics: Price Elasticities

1a)

Price elasticity of demand (PED) measures the degree of responsiveness of the quantity demanded of a good to a given change in price of the good itself, ceteris paribus. It is found by taking the percentage change in quantity demanded of good X divided by the percentage change in the price of good X.

The numerical value of the price elasticity of demand is always negative due to the inverse relationship between quantity demanded and price as stated in the law of demand. When we interpret the value of the price elasticity of demand, we just quote the absolute value. The absolute value of PED range from zero to infinity.

When PED is greater than one, the demand for the good is said to be price elastic. It means that a proportionate change in price causes a more than proportionate change in quantity demanded, ceteris paribus.

When PED is less than one, demand for the good is said to be price inelastic. This means that a proportionate change in price of the good causes a less than proportionate change in quantity demanded, ceteris paribus.

Different products have different price elastic ties due to a number of factors. Firstly the availability and closeness of substitutes. The more easily available and closer the substitutes for the good, the more price elastic will be the demand for the good. The availability of substitutes can be affected by the definition of market and the time span under consideration.

The elasticity of demand in any market depends on how we draw boundaries of the market. Broadly defined goods such as sports shoes tend to have higher price inelastic demand than narrowly defined goods for example Nike sports shoes, because it is more difficult to find good substitutes for sports shoes.

The demand for a product tend to be price inelastic in the short run but becomes more price elastic in the long run. This is because consumers will replace the products with new substitutes over time and their habits may change over time. There are more options available in the long run and consumers' purchases are more likely to be more responsive to price changes in the long run.

Another factor that affects the PED of a product is the proportion of family income spent on the good. The smaller the proportion of family income spent on the good, the more price inelastic will be the demand for the good. And example will be salt which is inexpensive and accounts for a tiny proportion of a family income. When the price of salt increases significantly by 50% from 1$ to $1.50, it does not affect the family's income significantly and reduction in consumption is negligible, which means that its demand is price inelastic.

Another factor is the nature of the good. The demand for a necessity, like food for example is likely to be more price inelastic than the demand for luxury goods like branded products such as Rolex watches. However, whether a good is a necessity or a luxury depends not on the intrinsic properties of the good but on the preferences of the buyer. As an example Europenas may not regard rice as a basic necessity.

Lastly, the degree of necessity of the good will affect the PED of the product.

The greater the need for the good, the more price inelastic will be the demand for the good. Cigarettes is one example of a habitually consume good which is price inelastic. Considerable increase in their prices would not greatly deter habitual consumers from their consumption as habits die hard.

The income elasticity of demand