The Concept of Price Elasticity of Demand - Article Example

Assignment 1 The concept of Price Elasticity of Demand The price elasticity of demand is measured by the percentage increase or decrease in quantity demanded in relation to the percentage increase or decrease in price. In other words, if the percentage increase or decrease is greater than increase or decrease in price the demand is elastic and the co-efficient of price elasticity is greater than 1. If the percentage increases or decrease in quantity demanded is equal to the percentage increase or decrease in price then the price elasticity in unitary and the price elasticity are equal to 1. On the contrary, if the percentage in crease or decrease in quantity demanded is less than the percentage increase or decrease in price then the price elasticity of demand is in elastic and the price elasticity of demand is less than 1. As the demand curve slopes down the relationship between the price and quantity demanded can be depicted by a diagram and see how the shape of the demand curve changes if the price changes for the three categories of price elasticity of demand such as elastic, unitary and inelastic. Elastic demand curve P1 Elastic Demand Curve P2 Q1 Q2 Demand curve when the Price elasticity of demand is unitary P1’ P2’ Q1’ Q2’ Inelastic demand curve P’1 P’2 Q’1 Q’2 As depicted in the above diagrams of elastic, unitary and inelastic demand curves one can see the slope of the curve is getting steeper when the price elasticity of demand is decreasing. In addition, in the elastic demand curve diagram the total revenue is increasing when the price reduces from P1 to P2 because the quantity is increasing more compared to the price reduction and there fore the total revenue increases if the demand is elastic. In the second diagram when the price elasticity is equal to 1 the total revenue do not change because the price change percentage and quantity change percentage is equal. It can be seen from the unitary price elasticity demand curve diagram when the price is reduced from P1’ to P2’ the quantity is increased by the same percentage from Q1’ to Q2’. And the total revenue does not change when the price reduced or increased. However, as depicted in the inelastic demand curve when the price is reduced from P’1 to P’2 the quantity demanded is increased by a lesser percentage than the price reduction and there fore the total revenue is reduced. There fore the consequences of price increase or reduction when the price elasticity is elastic, unitary and inelastic can be summarized as below. Price Elasticity of Demand Price change Total revenue change Elasticity greater than price increase reduction in revenue Or elastic demand price reduction increase in revenue Elasticity is equal to 1 price increase no change in revenue Or Elasticity is unitary price reduction no change in revenue Elasticity less than 1 price increase increase in revenue Or inelastic demand price reduction reduction in revenue Factors affecting price elasticity of demand The price elasticity of demand depends on several factors. The most important factors are whether the product concerned is produced by a monopoly industry or by a competitive industry structure where there exist many substitutes. For example if say in a mobile telephone market there exist many companies competing and customers can switch to other companies with little switching costs then the demand for the product will be most probably elastic. However, if there is considerable switching costs then the demand will be inelastic. In contrast if say railway company provides services say in peak periods then with little competition from other railway companies and there exist little choices for such services the demand for rail services in peak periods will be inelastic. However, in off peak periods the demand for rail services becomes elastic because the customers can use other modes of transport if the prices are high and they have more choices in off peak periods. The other factor, which affects elasticity of demand, is whether it is a necessary product or luxury product. Necessary products are mostly inelastic compared to luxury products. However, the degree of elasticity differ for necessary depends on substitutes as well as for luxury products and whether the market structure is competitive, monopoly or imperfect competition or oligopoly market structure. The other factors affecting the elasticity of demand is the consumer buying habits. For example the demand for alcohol and Cigarettes tend to be inelastic than elastic. The other factor, which affects the price elasticity of demand, is the percentage of income spent on by consumers of a product. If the percentage is higher then the elasticity tends to be more elastic than when the percentage of income spent on it is lesser. In addition, in short term most products are inelastic in demand than in the longer term because the customers can change to other choices comparing prices and quality in the loner term than in the short term. As well, when the general economic condition is positive the demand tends to be more inelastic compared to when the general economic condition is negative. Implication of price elasticity of demand for businesses and government As discussed above the price elasticity of demand is crucial for businesses because the price elasticity of demand has implications for setting prices of their goods and services as the price elasticity of demand has an impact on total revenue and yield management. For example a monopoly company is setting its prices for its services and say its peak period demand is inelastic and off peak period demand is elastic then setting higher prices in peak period and setting low prices in off peak periods and using price discrimination can maximise revenue or yield. In addition, by considering the factors affecting the price elasticity of demand a business can determine to some extent the price elasticity of demand and there fore enable to set prices on the basis of the price elasticity information in to consideration. For example if a company knows that switching cost affects the price elasticity of demand by increasing the switching cost of their services they can make the demand inelastic charge higher prices because the customers will not be able to switch to other companies easily if switching costs are higher. The telecommunication service providers can use this information to maintain their market share by knowing that switching costs affects the price elasticity of demand and by increasing the switching costs they can restrict customers choosing services form their competitors. In addition, in competitive markets the businesses must consider price as a competitive strategy when there are similar products and substitutes for their products because as explained above the price elasticity in these conditions will be mostly elastic and there fore affect sales then other factors. That is the businesses must consider the market structure because as explained above these factors affect the price elasticity of demand and it has impact on the yield level of the company. For the government in imposing indirect taxes it must consider price elasticity of demand because the imposition of taxes increase the prices because it affect the supply of these products and if they are elastic the consumers will reduce their purchases more the price increases due to the tax imposition and there fore less tax will be paid if the price elasticity of demand is inelastic. That is the government must not impose taxes on elastic goods because they may not be able to collect sufficient taxes compared to if they impose taxes on inelastic goods. For example governments impose taxes on alcohol and demand, which is dependent on habits than on price and the demand is inelastic rather than elastic. As well, if they are a monopoly supplier of any business services like rail or transport tolls they can charge higher prices in peak periods and low prices on off peak periods because the price elasticity of demand is inelastic in peak periods compared to off peak periods. That is they can use the price discrimination strategy to maximise revenue. In addition as explained above if the market is monopolistic in nature they may introduce more competition and regulation of prices to protect customers from price maintenance practices and anti competitive practices by these monopolies so that the market becomes become more competitive and there fore the demand becomes elastic than inelastic. . Assignment 2 This case of Les manufacturers offering Mary and James to become wholesalers for the sale of their new office equipment for commission is governed by the rules of offer and acceptance and particularly relating to postal acceptance of offer. An agreement becomes a contract if there is availed offer and there is unconditional acceptance and in general the acceptance in communicated to the person offering to make an agreement. In this case Les has offered by sending a letter to Mary to accept his offer to become a wholesaler of his new office equipment and he has implied that if he does not hear from her that he assumes she accepts her offer. There fore the communication is irrelevant in this case because the courts will imply from the letter that communication of acceptance is vital for the formation of a contract but the implied terms of the letter indicates the communication is not necessary in this case. In addition, applying the rules of acceptance for postal acceptance the acceptance happens when the acceptance letter is posted not received by the other party or the person offering. There fore in this case there is a valied offer and also a valied acceptance and there fore a binding contract has been established. In this context, Les manufacturers have legal obligation under the contract common law as they may be facing damages if they breach the contract if Mary file action that there is binding contract and less has breached the contract and can sue for damages or the court under certain circumstances can order specific performance to honour the contract. In relation to James Les did not offer him the opportunity to e his wholesaler. There fore there is no offer. Les cannot argue legally on the basis that he has discussed with James as a wholesaler and according to offer and he was willing to act given the opportunity. This is because the offer in general is not an offer and it must be specific. According to the rules of offer. There fore the acceptance of James to Les is null and void as there is no offer in the first place. There fore in accordance with the rules of offer and acceptance there is no contract. There fore neither party has any rights or obligation, as the contract is null and void. In this context Mary can file an action for injunction to stop the contract if the contract is not executed. As discussed above of this case Mary has some legal rights arising from a binding contract and Les and James do not have any rights arising from a contract because at common law they do not have any legal rights or obligation because there is no contract because there is no offer by Les and there fore no acceptance by James. References Assignment 1 Keat, P and Young, P. Chapter 4 Demand Elasticity. (Goggle) [Internet] Available at: http://libweb.anglia.ac.uk/referencing/harvard.htm?harvard_id=39#39 [Accessed: 25 November 2007] Tutor 2u. Price Elasticity of Demand. (tutor 2u.net) [Internet] Available at: http://www.wdcweb.info/clydebank/documents/2_-_Price_Elasticity_of_Demand.ppt [Accessed: 25 November 2007] Tutor 2u. Price Elasticity of Demand. (tutor 2u.net) [Internet] Available at: http://www.tutor2u.net/economics/revision-notes/as-markets-price-elasticity-of-demand.html [Accessed: 25 November 2007] Assignment 2 Contract Formation – Offer and Acceptance. (law.anu.edu.au) [internet] Available at: http://law.anu.edu.au/colin/Lectures/off_acc.htm [Accessed: 25 November 2007] Stott, D. Should the Postal Acceptance Rule be Applied to E-mail?. (www.alsa.asn.au) Available at: http://www.alsa.asn.au/files/acj/1996/stott.html [Accessed: 25 November 2007] Read More