Question

Executives need an understanding of price elasticity of demand concept.

4.1 Discuss the various forms of price elasticity of demand and show how elasticity of demand affects the management decision making procedure in respect of setting prices for their products.

4.2 Distinguish between cross price elasticity of demand and income elasticity of demand and explain why these concepts are important to an Economist.

Answer 1

4.1

There are different forms of price elasticity of demand. The first form is perfectly elastic elasticity of demand that shows that value of elasticity is infinite. It shows that with slight change in price, demand vanishes. It is reflected by the demand curve for firms in perfect competition. The second form is relatively elastic price elasticity of demand, where elasticity is greater than 1 in absolute value. It means that % change in quantity demanded, is more than the % change in price. The third form is relatively inelastic price elasticity of demand, where elasticity is less than 1 in absolute value. It means that hat % change in quantity demanded, is less than the % change in price. The fourth form is perfectly inelastic price elasticity of demand where value of elasticity is zero. It means that quantity demanded, does not change, irrespective of the change in price. The fifth form is unitary elastic price elasticity of demand. here value of elasticity is 1 in absolute terms. It shows that hat % change in quantity demanded, is equal to the % change in price.

Price elasticity of demand, is very important for the management people and decisions makers as it is the elasticity of demand that is used to set the pricing decisions of the products. If demand is relatively inelastic, then price is kept high as demand does not decrease significantly with increase in price. So, they can fetch higher revenue. But, when the demand is elastic, then price is set to be competitive in nature, so that revenue is maximized for the company. Hence, price elasticity of demand is very important for the decisions makers.

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4.2

Cross price elasticity of demand, refers to the impact of change in price of one product, upon the demand of another product, whereas income elasticity of demand tells the change in demand due to change in income. These concepts are very important to the economists, as it helps to study the relationship between complements or substitutes as well as impact of income upon demand. On the basis of these information, economists help government and organization to plan for the future and help meet the demand requirements in the market.