Price Elasticity of Demand - Essay Example

?Price Elasti of Demand Courting a critical juncture that the world is facing an energy crisis that would eventually might lead to absolute halt of all sorts of economic growth and development, an alternative energy source that might be able to replace the fossil fuel dependency of human civilization does attract substantial attention. Nowadays bio fuels are considered as one of the possible ways towards the replacement of fossil fuel. Corn is considered as an important raw material for Ethanol, which is mixed with gasoline and used as fuel. Considering this situation corn might become an important source of alternative energy in times to come. This way corn serves a two-way purpose and that will definitely increase its demand. Corn and soybean are considered as substitutes and according to economic theory if demand for a product raises then the demand for its substitute will obviously decline. Following this principle the price of the soybean will decline. Again corn and soybean shares the same habitat for production, especially the prime raw material for any agricultural production the land. Now an increased demand for corn will also lead to a higher price for the same, since price and demand are directly correlated. A product that is offering higher price will definitely translate into higher profit for the producer and an immediate shift from production of soybean to that of corn. Higher percentage of land and effort will now be directed towards corn production than that of soybean (Pearce, 2006). The above discussion seems economically sound, however a careful investigation might reveal that this holds for short run. Once the producer starts to devote more land and other raw materials to the production of corn, corn production will rise and production of soybean will fall. Hence in long run owing to higher supply of corn its price will come down and that of soybean will go up as it is scarce now. These points to the fact that in long run an eventual equilibrium will be reached where both will be produced at an optimum level for the economy. Last but not the least since, energy has an ever increasing demand, hence if corn can project itself as a viable source of alternative energy in long run that have enough potential to replace fossil fuels then the trend for substituting soybean production land and raw material in favor of the corn might show a sustained trend, with soybean production looking for an alternative way as itself is a nutritious and valuable food source along with a rich source for food oil. It is obvious that since there is high need of alternative form of energy and that especially of bio fuel; corn oil as an important source of bio fuel will enjoy this boom in demand and price for this product will go up. The magnitude of this rise in price is subject to much debate. First of all if demand for a product is matched by its supply then the rise in price is minimal or zero. However if this is not the scenario that is there is excess demand then the price will go up. Interestingly it is worth noting that in case of excess supply the price might also go down even courting a rise in demand for the concerned product. The excess supply often follows a rise in demand owing to the behavioural pattern of the producer who might over estimate the rise in demand and increase his supply of corn in tune of his expectations. Apart from this demand-supply interaction, many other factors do operate while determining the fate of the corn oil. If people are well aware of the potential that corn oil holds as a fuel and alternative source of energy that will definitely translate into higher demand. Again this has to be also undertaken into the realm of analysis that whether any other form of substitutes to corn oil does exist, that might be cheaper, easily available in plenty and better source of energy. As a viable source of alternative energy in the long run corn oil will face quite a competition with Jatropha and Pongamia pinnata (Bridgewater, Halford and Karp, 2010, p. 236) and that outcome will have final verdict on its price. Since price is determined by the interaction of demand and supply along with the availability of substitute products, and many other associated things hence price of corn oil will rise if other things apart from demand for the same are assumed to remain unchanged. Price elasticity of demand refers to the percent change of quantity demanded for the product owing to the percent change of price for the same. In general it is negative since a rise in price mostly follows with a decline in demand for the same. (Mankiw, 2008) The price elasticity of demand depends on a cluster of other variables. If the goods concerned have many substitutes then the price elasticity of demand will be higher as the consumer courting a rise in price can easily shift to other substitute goods. As mentioned earlier that other forms of substitute bio fuels are available in the form of Jatropha and Pongamia; it implies corn oil will never run short of substitute products and that might lead to a higher price elasticity of demand for the product. (Bridgewater, Halford and Karp, 2010) Furthermore while considering the substitutes of fossil fuel and the bio fuel; the breadth of the substitutes also increases substantially this will also lead to higher price elasticity for corn oil. The elasticity will be substantially influenced by the person’s devotion of income towards the product the more it is the more elastic will be the elasticity of demand owing to the income effect (for the time being it is better to keep that out of the realm of the discussion). Necessity of a good will definitely result in lower price elasticity, corn oil is a bio fuel and when there will be no more fossil fuel would be left around us it might hold the key for future source of energy. In this term the price elasticity of demand for this product would be low. Brand loyalty is another thing that has been witnessed to influence the price elasticity of demand in a positive way for those who like to stick to a particular brand; however this seems to hold little merit in terms of corn oil. What have been discussed so far fails to announce the final verdict on the price elasticity of demand for the corn oil, courting this situation it is worth that all the possible situation of price elasticity of demand and their subsequent impact on the total revenue of the seller is discussed. If Ed depicts the price elasticity of demand of corn oil, then Ed = ?q/q/?p/p. The following table depicts the various values that Ed can have and their implication. It also illustrates the effect on the seller of the corn oil in subsequent price elasticity of demand for the corn oil. Value Implication or the various values for price elasticity of demand. Effect of the price elasticity of demand on Total revenue for the seller Ed = 0 The demand for corn oil is perfectly inelastic, that is rise in price of the corn oil will not change the quantity demanded for the same. Here, quantity demanded will remain unaltered even with the change in price, hence total revenue will rise owing to the rise in price. -1 Read More