Price, Income And Cross Elasticity Of Demand

1482 words - 6 pages

Explain what is meant by the terms price elasticity, income elasticity and cross elasticity of demand and discuss the main determinants of each of these. Discuss the importance of each of these to the decision making process within a typical business.Elasticity is the responsiveness to which one variable responds to a change in another variable Price elasticity of demand (PED) measures the responsiveness of quantity demanded of a product to a change in its price. If a relatively small change in price leads to a relatively large change in demand, the product is said to be 'elastic'.Whereas if quantity demanded is relatively unresponsive to a change in price the product is said to be 'inelastic'.Price elasticity of demand can be given a numerical value which is just a number and not in terms of any particular unit. The resulting numerical figure will always be a negative number due to the inverse relationship between price and quantity demanded, but can be ignored. This numerical figure can be calculated by:Price elasticity of demand = percentage change in quantity demanded Percentage change in price For example if the price of a product rises from £20 to £24, which is a 20%change and demand falls from 400 units to 300 units, which is a 25% change, the calculation will be:25% = -1.2520%When the percentage change in price leads to a smaller percentage change in quantity demanded price elasticity of demand will be a number between 0 and -1 and the product is said to be 'inelastic'.On the other hand when the percentage change in price leads to a larger percentage change in quantity demanded price elasticity of demand will be a number between -1 and - infinity and the product is said to be 'elastic' such as the product used in the example above.If the price elasticity of demand is exactly 1 the product is said to have 'unit'price elasticity of demand. This occurs when a percentage change in price leads to an equal percentage change in quantity demanded.If a change in price causes an infinite change in quantity demanded the product is said to have 'perfectly elastic' demand. For example if there were a number of people selling football shirts outside a football stadium, if one of the sellers lowered their price below all of their competitors, they may capture all of the customers going to the stadium.The final result is when a change in price causes no change to the quantity demanded and this is known as 'perfectly inelastic' demand. For example a person who has a serious illness and has to take drugs to survive may be prepared to purchase the same amount of the drugs however much the price rises and will not benefit in purchasing a larger quantity of the drugs if the price was to fall.There are many influences determining weather products will be elastic or inelastic for example if there are many close substitutes for a product, demand for it will tend to be elastic. An example of this would be a particular brand of paint, if'Dulux' were to...

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