ECONOMICS

Economics



Economics

Price Elasticity of Demand

a. Concept of price elasticity of demand and measured numerically.

The concept behind Price elasticity of demand is price sensitivity that is the changes that take place in the quantity demanded and price of quantity demanded. In order words, it is a degree of responsiveness of demand to change in its prices or it is a ratio of percentage change in demand for a product to the percentage in product price (Mankiw, 2012, p. 90).

For instance, airlines usually apply this concept. Throughout their peak seasons, airlines tickets are expensive as people are willing to purchase at higher prices as well. Hence, in peak seasons the demand is inelastic and company would be charging higher price for their services (ticket). In other season demand for airlines ticket is elastic.

In order to calculate Price Elasticity of Demand, the following formula is used:

Consider a tea selling at price $2. This selling price increased to $3 and due to increase in price the demand for tea declined from 30 cups to 28 cups. Hence, the price Elasticity will be calculated as followed:

Percentage change in demand = (28- 30) / 30

Percentage change in demand = (-2) / 50

Percentage change in demand = -0.066

Percentage change in price = (3 - 2) / 2

Percentage change in price = 0.5

Price elasticity of demand = (% change in demand) / (% change in price)

= - 0.066 /0.5

= -0.133

As demand Elasticity is less than one, this shows that demand is inelastic. Furthermore, one could state that for 50% increase in price, this has resulted reduction in demand by 6.6%. As it is negative, there is an inverse relationship between the price and demand for the product (Mankiw, 2012, p. 95).

b. The table below shows the quantity demanded and corresponding price for T-Shirts for a producer.

The following is the table showing quantity demanded and corresponding price for T-Shirts for a producer

Price

Quantity

Percentage change in demand

Percentage change in price

Price Elasticity of demand

Total consumer expenditure/producer revenue

Marginal Revenue

£ Per Unit

Units (000s)

 

£s

£s

20

300

0.267

-0.100

-2.67

6000

0.00

18

380

0.211

-0.111

-1.89

6840

10.50

16

460

0.174

-0.125

-1.39

7360

6.50

14

540

0.148

-0.143

-1.04

7560

2.50

12

620

0.129

-0.167

-0.77

7440

-1.50

10

700

0.114

-0.200

-0.57

7000

-5.50

8

780

0.103

-0.250

-0.41

6240

-9.50

6

860

 

 

 

5160

-13.50

c. Discuss the relationship between the price elasticity of demand and the total revenue for the producer of T-Shirt for the following:

i. When the price changes from £16 to £14

When price changed from £16 to £14, the quantity demand increased from460 to 540. Due to this, the Percentage change in demand is 0.174 while Percentage change in price is -0.125, and ...