Question

Elasticity of demand is a very important concept in economics as it shows the responsiveness of quantity demand to various factors that affect demand. Assume the price of commodity (X) increases from k6 to k9 and because of this increase in price quantity demanded changes from 3units to 15units. a) What type of commodity is being described above? Give reasons b) Analyze the types of price elasticity of demand that you know. c) Calculate the price elasticity of demand.(9marks) d) Comment on your answer.

Answer 1

a) An increase in the price from k6 to k9 results in increase in quantity demanded from 3 units to 15 units. Here, commodity X is a Veblen good which serve as status of symbol and which increases the social prestige of the buyers. An increase in the price of such goods causes an increase in the quantity demanded. The higher price makes the possession of such goods more prestigious. Here, an increase in the price of commodity X results in increase in the quantity demanded of commodity X, hence it is a Veblen good.

b) Price elasticity of demand measures the degree of responsiveness of the quantity demanded of a commodity to a change in the price. The various types of price elasticity of demand are-

1) Perfectly inelastic demand- when the quantity demanded of a commodity does not respond to a change in the price, elasticity of demand is zero. In such a case, quantity demanded remains the same, irrespective of any changes in the price.

2) Perfectly elastic demand- when the quantity demanded of a commodity changes by infinity to a very small change in price, the price elasticity of demand is infinite. A small change in the price causes the demand to change to infinity.

3) Unitary elastic demand- when a given percentage change in the price of the commodity causes an equivalent percentage change in the quantity demanded, then price elasticity of demand is said to be unitary elastic.

4) Elastic demand- When the percentage change in the quantity demanded of a commodity exceeds the percentage change in price, price elasticity of demand is said to be elastic.

5) Inelastic demand- when the percentage change in quantity demanded of a commodity is less than the percentage change in price, price elasticity of demand is said to be Inelastic. Quantity demanded changes by a smaller percentage than percentage change in price.

c) price elasticity of demand= % change in quantity demanded/ % change in price

initial price= k6, new price= k9

Change in price= k9- k6 = k3

So,Percentage change in price= change in price/initial price x 100

Percentage change in price= k3/k6 x 100

Percentage change in price= 3/6 x 100

Percentage change in price= 0.5 x 100

Percentage change in price= 50%

Now, initial quantity= 3 units, new quantity = 15 units

Change in quantity demanded= 15-3= 12 units

So, Percentage change in quantity demanded= change in quantity demanded/initial quantity x 100

Percentage change in quantity demanded= 12/3 x 100

Percentage change in quantity demanded= 4 x 100

Percentage change in quantity demanded= 400%

So, price elasticity of demand= 400% / 50%

Price elasticity of demand=8

​​​​​​Hence, price elasticity of demand for commodity X is 8

​​​​​​d) The price elasticity of demand for commodity X is 8. When percentage change in quantity demanded is more than percentage change in price, price elasticity of demand is greater than 1. Here, an increase in the price by 50% has resulted in increase in the quantity demanded by 400%. Hence, price elasticity of demand is elastic.