Question

What is price elasticity of demand? What are the determinants of price elasticity of demand. How does the concept of elasticity help in decision making and price setting. Provide examples to substantiate your responses and also cite the source of your information.

Answer 1

Price elasticity of demand means ratio of percentage change in demand to the percentage change in price of particular commodity.Price elasticity determine impact of demand when price of the commodity is altered.

Formula - dQ/Q ÷ dP/P

This formula yields inverse relationship between price and quantity demanded.

Determinants of price elasticity of demand -

1)Substitutes availability - price elasticity depend upon the kinds of substitutes availability .If close substitutes available ,demand tends to be elastic.in case price is rises then people shift towards close substitutes.If substitutes are not available People will have to buy good even when its price rises.

2) consumer spending- elasticity of demand depend upon how much consumer spend his income .Proportion of consumer 's income spent on a particular commodity also influences the elasticity of demand for it.

3) The number of uses of a commodity - The greater the number of uses to which a commodity can be put,the greater will be its price elasticity of demand.

4) complement goods - complement or joint demand affect the price elasticity of demand .

5) Time - Element of time influence the elasticity of demand for a commodity.if time is long then demand tends to be more elastic.

Price elasticity of demand can be useful to make crucial decisions like deciding the price of goods and services.any firm's primary aim is to earn profit or maximize revenue.so producer wants to increase price of its product for maximize profit.

While course of increasing price,the producer must not forget about demand and price inverse relationship .they know that demand falls with rise in price.thus they must increase price of their commodity to that level where their desired or optimal profit is achievable .