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Microeconomics and Market Systems - Assignment Example

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Microeconomics and Market Systems Date Abstract This assignment is an exercise in the concept of elasticity. The example presented is about a painter who uses 35 gallons of paint when the price of one gallon of paint is $3.00…
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Microeconomics and Market Systems This assignment is an exercise in the concept of elasti The example presented is about a painter who uses 35 gallons of paint when the price of one gallon of paint is $3.00. However, when the price of a gallon of paint increased to $3.50, his usage decreased to 20 gallons. The exercise aims to introduce the concept of elasticity by illustrating how the demand for a product will decrease if the price is increased. In the example, one observes that the demand for paint is elastic because it is sensitive to price changes. This is clearly shown when the price elasticity of demand was computed and resulted in a value greater than one. Microeconomics and Market Systems 1. Write a paragraph or two to explain the concept of elasticity. “Elasticity is a measure of responsiveness. It tells how much one thing changes when you change something else that affects it” (Baker, 2006). Price elasticity of demand (PED) measures the responsiveness of demand for a product if its price is either increased or decreased. The formula for price elasticity of demand is percentage change in quantity demanded divided by the percentage change in the price of the product. As explained by Riley, if PED is greater than one, then the demand for the product is elastic, which means that demand is sensitive to price changes and responds more than proportionately to a change in price (2006). Furthermore, if PED is equal to one, then the demand is unit elastic. And lastly, if PED is less than one, demand is inelastic, which means that the change in demand will be proportionately smaller than the percentage change in price. 2. Compute the price elasticity of demand for paint and show your calculations. Price elasticity of demand = (%change in quantity demanded) / (% change in price) To calculate for the price elasticity of demand, we have to compute first the % change in quantity demanded and % change in price, as shown below: % change in quantity demanded is calculated as [(new quantity - old quantity) / old quantity]*100 In this case, quantity changed from 35 gallons of paint to 20 gallons Quantity changed from 35 gallons (old) to 20 gallons (new) so we would have: [(20-35)/35]*100. What would this be? = (-15/35)*100 = -.43*100 = -43% is the % change in quantity demanded %change in price is [(new price - old price) / old price]*100 In this case, price changed from $3.00 a gallon to $3.50 a gallon Price changed from $3.00 a gallon (old) to $3.50 a gallon (new) so we would have: [(3.5-3.0)/3.0]*100= .17 *100 = 17% is the % change in the price Since % change in quantity is negative (i.e. quantity demanded has decreased) and % change in price is positive (i.e. price has increased), the elasticity of demand will be a negative number. However, we will report the absolute value of this as the elasticity of demand, i.e. the positive value. Price elasticity of demand = (%change in quantity demanded) / (% change in price) So, put the two % changes we have just calculated in this formula and the price elasticity of demand will be as follows: Price elasticity of demand = - 43% / 17% = -2.53 or |-2.53| or 2.53 3. Decide whether the demand for paint is elastic, unitary elastic, or inelastic. The demand for paint is elastic. Elasticity as we just calculated is 2.53 which is > 1. If elasticity is > 1, the demand is elastic. 4. Explain your reasoning and interpret your results. In the example given, we see that when the price of the paint was increase by $0.50, representing a 17% increase in price, the demand for the paint decreased from 35 gallons to 20 gallons or a 43% decrease in quantity demanded. This resulted in a price elasticity of 2.53, which is greater than one; which means that the demand is elastic. Following this trend, we can say that if the price of paint is increased, there will be a subsequent decrease in its demand. References Baker, S. L. (2006). Elasticity. Retrieved September 2, 2011, from Riley, G. (2006, September). Price elasticity of demand. Retrieved September 2, 2011, from demand.html Read More
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