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Elasticity of Demand - Assignment Example

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This essay discusses elasticity of demand which is defined as the measurement of “the rate of response of quantity demanded due to a price change” (Moffat) or alternatively how consumers react to a change in price. For example, while someone may pay almost any price for the product…
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Elasticity of Demand
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Download file to see previous pages When the price elasticity of demand for a good is inelastic (|Ed| < 1), the percentage change in quantity demanded is smaller than that in price. So, when the price is raised, the total revenue of producers rises, and vice versa. When the price elasticity of demand for a good is elastic (|Ed| > 1), the percentage change in quantity demanded is greater than that in price. Hence, when the price is raised, the total revenue of producers falls, and vice versa.
As an example; Company W produces a product called a widget. Company W sells their widgets for $10 and there is a demand of 10. The company had tried to raise the price to $20 previously, and the demand lowered to 5 they also changed the price to $5 and the demand rose to 25.
. Company W uses the mathematical formula for measuring the price elasticity of demand in order to determine which of these options is best for the company. The formula is PEoD = (% Change in Quantity Demanded)/(% Change in Price). (Moffatt) In order to determine the elasticity of demand, Company W must first determine the percentage change in demand and price. The formulas for determining the percentage change are:
In order to determine the elasticity of demand, the values are inserted into the equation first for the price at $5 [ 5-10/5] which gives a percentage of change in the price of -.0025%. The values for demand are entered [25-10/10] which gives a percentage of change in demand of .025%. These values are inserted into the formula for the elasticity of demand [ (0.025%)(-0.0025%) ] and a resulting price elasticity of demand coefficient of -0.0000625 is reached. According to Mike Moffat, “we always ignore the negative sign when analyzing price elasticity, so PEoD is always positive.”
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