Price Elasticity of Demand - Assignment Example

Price Elasticity of DemandEffect of Increase in Demand on Supply of Substitute Good If corn is discovered as an alternative source of energy, its demand increases prompting a scarcity of corn. The buyers will compete for the scarce corn thereby pushing the price of corn up. This acts as an incentive for farmers to produce more corn and sell at high price as the law of supply states that price of a good is directly related to its supply; if price increases, quantity supplied increases (Tucker, 2009).

However, the supply of corn also depends on availability of resources or inputs such as land and labor, prices of substitutes, and number of farmers. If more farmers decide to produce corn, the demand will be met. The price of soybean in relation to corn also matters. The increase in price of corn prompts demand for soybean but demand for soybean also depends on tastes and preference and income. Although the price of soybean decreases, it does not result to increase in its demand since preference is on corn which has multipurpose use hence income will be spent on corn and buyers will incur opportunity cost of buying soybean.

Since both cereals use same raw materials, farmers will shift production factors from production of soybean to corn production hence reducing acreage on soybean for planting more corn.Question 2:Price of Corn Oil The price of commodities is determined by forces of demand and supply. As long as the quantity of corn oil produced is equal to quantity demanded, the market will be at equilibrium price and quantity. Since the demand for corn is up it means demand for corn oil is also up hence quantity demanded is higher than quantity supplied.

The buyers will compete for the available corn oil hence pushes the prices up. Baumol & Blinder (2009 p 57) argues that quantity demanded is also dependent on; income, tastes, price of other products and population size. If price of corn oil goes up, buyers in response to price change will cut quantity of demand of corn oil to alternative sources of energy which are cheaper especially if price elasticity of demand of corn is high. If buyers have increased income and have high income elasticity they buy more corn oil thus increasing demand and pushing prices up.

Question 3:Price Elasticity of Demand (PEoD) PEoD is used to measure the response of consumers demand to price changes all factors held constant (Moffat, 2010). It’s the proportionate change in quantity demanded over proportionate change in price. PEoD is affected by factors such as; substitutes, degree of luxury, time period and price points (Bochholz, 1996). The higher the price elasticity, the more sensitive consumers are to price changes (Moffat, 2010). If price elasticity of corn oil is high, then consumers are sensitive to price changes thus if price increases, consumers will demand less goods thus the quantity of corn oil sold decreases.

Since sensitivity to price is high, a lot of sales will be lost as compared to the sales made as result of price increase hence loss of revenue. If PEoD is equal to 1, then revenue will remain constant but if PEoD is low, consumers do not respond to price change hence sellers will have increased revenue from sale of corn oil. Price elasticity of supply determines how suppliers react to price changes, whether they increase quantity supplied or not. If price elasticity of supply of corn oil is high, an increase in price makes sellers to reduce quantity of corn oil so as to keep balance and not lose revenue.

The income elasticity of demand also plays a part. If it is high, consumers demand is sensitive to income thus an increase in income is accompanied by increased demand for corn oil no matter the price thus raising sellers’ revenue. A perfectly inelastic demand is therefore favorable to suppliers as it earns them more profit (Tucker, 2009).ReferencesBaumol, W., Blinder, A. Economics: Principles and Policy. USA, Cengage Learning.Bochholz, G. 1996. From Here to Economy: A Shortcut to Economic Literacy.

New York, Plume publishers.Moffatt, M. 2010. “Price Elasticity of Demand”. About.com Guide. Retrieved May 6 2010 from http://www.economics.about.com/cs/micfrohelp/a/priceelasticity.htmTucker, B. 2009. Survey of Economics. (6ed). USA, Cengage learning.