Price Elasticity Of Demand - Term Paper Example

Coarse: Price Elasti of Demand Introduction This paper gives a clear insight on the microeconomic element of price elasticity of demand. It covers all the formulas that are used in computing price elasticity of demand, cross elasticity of demand and income elasticity of demand. Finally the cover interprets different graphs and signs of coefficient of elasticity of demand. Price elasticity of demand can be defined as “a measure of responsiveness or sensitivity of consumers to price change”. (Cordes, J. J et al p102)With some products, consumers have a higher responsiveness to price changes. (Daly H.E, 2004 p146) These products are said to have a relatively elastic demand. (Daly H.E, 2004 p146) On the other hand, some products have a low responsive to price changes. The demand for these products is said to be relatively inelastic. (Daly H.E, 2004 p146) The degree of price elasticity or inelasticity of demand is measured by the coefficient of elasticity. (Pindyck, R. S and Rubinfeld, P. L, 2005) It can be defined as; The percentage changes in the equation are computed by dividing the change in quantity by the original quantity demanded and by dividing the change in price by the original price. (Boyes, W. J, and Melvin, M, 2008p84)Therefore, the formula can be restated as; There are two main reasons why we use percentages instead of absolute amounts. They are; If absolute changes are used, the choice of units will be arbitrary affect the impression of the consumers’ responsiveness. (Lipsey R.G and Christal K.A2007pp66) For example, if the price of cereals changes from $10 to $9 and the quantity demanded changed from 60 to 100 packets. The coefficient of price elasticity of demand will be 40. It will be seen that consumers are very sensitive to price change and the demand will be elastic. But if the monetary units are change from dollars to pennies we see that change of 100 pennies causes a change of 40 packets of cereals. This will falsely make people believe that demand is inelastic. To eliminate this problem percentage changes are used. (Lipsey R.G and Christal K.A2007pp66) By using percentage, consumers’ responsiveness to price changes of different products can be easily compared. For example, if two products are taken i.e. cereals and computers. It is easier to compare the effects on quantity demanded of $1 increase in price of a $300 computer and $1 dollar increase in the price of $1 soft drink.(Lipsey R.G and Christal K.A2007pp66) Various interpretations of price elasticity of demand coefficient When Ed>1, the demand is said to be elastic. This occurs when a specific change in price results to a larger percentage change in quantity demanded.(Mankiw N.G,1998p93) Graphically it can be illustrated as follows; Elastic demand curve P  Ed>1 0 Q When Ed Read More