Case study Economics - Essay Example

The first term on the right hand side depicts the amount that is demanded if the product is freely available, i.e if p = 0, Qd = 100. Since, this term is oblivious to price movements, and it is the coefficient of the second term on the right hand side that actually determines the extent of influence price changes can exert on demanded quantities, the second term is relatively much more important from the aspect of decision making perspective of the suppliers in particularly deciding the price to charge.

More than the direction of the relation (inverse in general), it is the exact nature of the relation reflected in the extent to which demand is influenced by price movements which is considered important in most cases and in our case specially as we are dealing with the issue of tax incidences. This extent of influence that price changes have on the quantity demanded, or in other words, the degree of responsiveness of quantity demanded to price changes is known as the price elasticity of demand.

In more specific terms, the percentage change in quantity demanded due to a percentage change in price is known as the price elasticity of demand. There are two alternative ways in which we can calculate such percentage changes: Observe in this measure, the elasticity of demand is measured for a particular point only. For a different value of p in the function, we are measuring the elasticity for a different point on the demand curve1 and get different values of price elasticity. For this very reason this particular measure of price elasticity is known as ‘point price elasticity of demand’.

The alternative that shows the way out of this difficulty is the ‘arc’ elasticity measure. It measures the elasticity over an arc of the demand curve using the midpoint of the arc as a reference. The p and Q values are essentially averages of their