Price Elasticity of Demand and Supply

Price Elasticity of Demand and Supply

Introduction

A flower shop is newly opened and one is trying to understand the pricing issues. It is said that price elasticities are an important factor in determining the prices and the supply of the products. The importance of the elasticity and the determinants will be looked upon.

Discussion

Elasticity

In general terms elasticity measures the response of the dependant variable for any changes that occurs in independent variable. Therefore, demand elasticity is response of quantity demanded that occurs in price. The dependant variable is the quantity demanded whereas the independent variable is the price.

Elastic demand can be defined as quantity demand being very responsive to changes in prices(Andrews & Benzing,, 2010). It means a little bit change in prices of any commodity will largely affect the demand of it. If there is rise in prices, the quantity demand will fall with a large amount and vice versa. An infinite change will occur in demand if the demand is perfectly elastic. The negative sign shows the inverse relationship of demand and price.

Inelastic demand can be defined as quantity demand is not so responsive to changes in prices. This means that any change in price will not have a large or no impact at all on the quantity demand. If the prices rise, the quantity demand for the commodity will remain the same. Absolute no change in demand will occur if the demand is perfectly inelastic.

Unit elastic is quantity demand response by completely offsetting the changes in prices.

If price elasticity of demand (PED)

If the value is less than 1, it is inelastic

Value greater than 1, its elastic

Perfectly elastic if zero

Infinite shows perfectly inelastic

Determinants of elasticity

Nature of the goods

There are certain goods which are necessities and are needed for survival. Some of these goods are medicines, milk flour and other food items (Mankiw, 2011). These goods are the need and no matter how much the prices increase, quantity demanded will not be responsive. These goods will be categorized as demand inelastic. There are some goods that are habitual for instance cigarettes, drugs which are difficult to give up. The change in prices will not affect the demand of these goods as well.

However there are goods that are luxuries, which are not essential for survival. Examples of these goods are luxurious cars, colored lenses, perfumes etc. The increase in price will affect the quantity demanded which makes them demand elastic.

Number of substitutes

If a product has a number of substitutes, quantity demanded will be very elastic. As the prices rise of the product, quantity demand will switch to its substitutes as it is very responsive to price. However, when there is monopoly and there are no substitutes, the product will become inelastic and quantity demanded will be not responsive.

Proportion of income spent on good

For instance if one is buying a car which is heavily priced and there is an increase in the price by 2%. This increase may change one's mind from buying the car as ...