Question

Discuss different elasticities and their importance to consumers and businesses.

Answer 1

Answer

The elasticity of demand for a good is the responsiveness of the demand for that good for the change in one of the factors that determine the demand for that good.So the elasticity of the demand for a good shows the proportionate change in the demand for that good for a proportionate change in one of the factors that determine the demand for that good.

There are many factors that determine the demand for a good.Some of the important factors that determine the demand for a good are, price of that good, prices of the related goods, consumer's money income, consumer's taste and preferences, time,consumer's expectation of the future price change, etc. Two important elasticities of demand that are frequently discussed in explaining the consumer behavior in Economics, are price elasticity of demand, and the income elasticity of demand.

For the consumer and business, the price elasticity of demand is very important to take the decision of price change and simultaneously the quantity demand The price elasticity of demand can be of two types , own price elasticity of demand and cross-price elasticity of demand.

Price elasticity of demand : It is the responsiveness of the demand for a good for the change in the price of that good , or the prices of the related goods.

a) Own price elasticity of demand : It is the responsiveness of the demand for a good for the change in its own price.

Let the consumer purchases good 'X' and the price of good 'X' is 'P_X' .

  Own price elasticity of demand for good 'X' (_X) = ( X / X ) / ( P_X / P_X ) , where '' stands for 'change'.

It is the ratio of the relative change in demand to the relative change in price.

Or, (_X) = ( X / P_X ) / P_X / X ), where  '( X / P_X )' is the inverse of the slope of the demand curve for good 'X' in the graph, where the quantity demand for good 'X' is measured on the horizontal axis, and the price of good 'X' is measured on the vertical axis.So the slope of the demand curve is, P_X / X.

For the normal good, if price rises, the demand for that good falls. So the slope of the demand curve is negative.

The value of the price elasticity of demand = 0 , if the demand doesn't change for the change in price.

The value of the price elasticity of demand = 1, if the demand changes exactly at the same proportion of the change in price.

The value of the price elasticity of demand > 1, if the demand changes more than the change in price.

The value of the price elasticity of demand < 1, if the demand changes less than the change in price.

The value of the price elasticity of demand = ∞, if the demand changes infinitely for the change in price.

b) Cross-price elasticity of demand : In real world, a consumer purchases many goods. Let, here the consumer purchases two goods, good 'X', and good 'Y'. Let the price of good 'X' is P_X and the price of good 'Y' is P_Y. Good 'X' and good 'Y' are related goods. So the change in the price of one of the goods, will affect the demand for the other good.

  Cross price elasticity of demand for good 'X' (_XY) =   ( X / X ) / ( P_Y / P_Y ) , where '' stands for 'change'.

Good 'X' and 'Y' are said to be substitute goods, if the rise of the price of one of the goods raises the demand for the other good and vice versa , like tea and coffee. Good 'X' and 'Y' are said to be complementary goods, if the rise of the price of one of the goods decreases the demand for the other good and vice versa , like , car and petrol

_XY = 0 , when goods are non-related

_XY >0, when the goods are substitute

_XY <0 , when the goods are complementary

Importance of elasticities to consumers and businesses : For a very necessary commodities, the price elasticity of demand is inelastic, whose value is between '0' to less than '1'. So the change in price doesn't impact a lot for these goods.If the producer changes the price of these goods, it won't hamper their sales, and thus revenue and profit. The opposite happens for the goods whose elasticity is highly elastic.