Question

Select a product currently sold by your company and discuss if the pricing of that product has a high or low elasticity of demand. If this is not possible, select a product with which you are familiar and evaluate the price elasticity of that product in the current market. Please need 750 word paper

Answer 1

The law of demand states that there is an inverse relationship between the quantity purchased and the price of the commodity.

However, the law of demand does not capture the responsiveness of quantity demanded due to change in price.

So Marshall introduced the concept of elasticity.

Price elasticity measures the responsiveness of quantity demanded in the market due to a given change in price.

Mathematically, it can be written as,

,

Where,

Ep = price elasticity of demand,

ΔQ = change in quantity demanded,

ΔP = change in price,

P = initial price,

Q = initial quantity demanded.

Example: Petrol

So, let us evaluate the price elasticity of petrol.

Petrol in US can be considered as a “necessity good”, because mostly people use their own car as the primary form of transportation. Moreover, petrol has very few substitutes because of the following factors:

• Since, driving is a necessity for many people, those with cars will definitely need to buy petrol
• Public transportation such as bus or train or carpooling are weak substitutes, because they are subject to availability
• Another substitute could be using automobiles that run on alternative energy such as electricity. But electric cars are far more expensive and the infrastructure for charging them is not widely popular or established in the US
• Walking or biking can also be considered as substitutes for petrol consumption. But, there is a constraint to the distance one can walk or ride a bike.

So, without available alternatives, the demand for petrol remains largely unchanged. Since the quantity of petrol demanded is relatively insensitive to the price rise, petrol is said to have a relatively inelastic price elasticity of demand. This is because petrol is a necessity for daily functions and it cannot be substituted for another good.

Considering these two factors, we can say that petrol is relatively inelastic. So when the price of petrol increases, the demand remains largely unchanged and other household purchases may get delayed or curtailed to adjust with this price rise.

When we say petrol is price inelastic, we mean that a unit increase in price results in smaller percentage fall in quantity demanded.

Mathematically, if we assume that the price pf petrol rises from 10$ to 14$ i.e., by 40%, but quantity demanded of petrol falls from 88 units to 80 units (i.e., by 10%),

Then, price elasticity of petrol = (-8/4)*(10/88) = - 0.23

Thus, in the short run demand is likely to be more inelastic (i.e., price elasticity less than 1).

However, in the long run, consumers become more aware of the alternatives and so it can be said that the longer the time has elapsed since a price change, the more elastic demand for petrol is.

For example: When the price of petrol increases, in the short run people keep buying it out of habit. But when they realize that this change in price is permanent, they will take spend more energy and time in looking for alternatives. For example, people choose to live close to their workplaces to reduce the distance travelled to and from work. So factors like distance from work, access to public transportation, and proximity to shopping are alternatives that people find and thus demand will fall more in response to price rise in the long run. Moreover, over time people may switch to automobiles which run on alternative energy sources like natural gas, hydrogen or solar panels. So demand for petrol will be more price elastic over time.

Let us consider another example where we can compare the responsiveness of the change in quantity demanded of petrol in the short run and in the long run due to increase in the price of petrol.

In the above graph, we see that in the short run, when the price of petrol increases from 7$ o 10$, then there is a slight fall in quantity demanded from 13 units to 12 units.

Mathematically, it can be stated that 43% increase in the price of petrol has resulted in only 7.7% fall in quantity demanded. Thus in the short run, petrol is price inelastic.

However, in the long run, people find other alternatives as a response of the price rise and there is a significant fall in the quantity demanded.

Due to 43% increase in price of petrol, the quantity demanded of petrol has reduced by 62%.

Thus demand tends to be more price inelastic in the short-run as consumers don’t have time to find alternatives. But in the long-run, consumers become more aware of alternatives and thus demand tends to be price elastic in the long run.