Question

The price elasticity of demand is people’s responsiveness of quantity demanded (or consumption) when there is a change in price.

Respond to the following:

• Identify the determinants of the price elasticity of demand. Explain each one.
• Determine whether each of the following items is elastic or inelastic: bottled water, gourmet coffee, Apple cell phones, and gasoline. Explain your reasoning.
• Distinguish between a necessity and a luxury.
• How are the price elasticity of demand and total revenue related? Why is the price elasticity of demand important to pricing?

Answer 1

The elasticity of demand shows the responsiveness of quantity demanded due to change in price of the good. In other words, it is ratio of percentage change in quantity demanded and percentage change in price.

Explanation:

1.

Determinants of Elasticity of demand:

Nature of Commodity:

There are two type of commodities which are necessary and luxury goods. The necessary goods have relatively inelastic demand as compared to luxury goods. For Example, Air Condition is luxury good and it has elastic demand. On the other hand, salt is necessary good and its demand is inelastic.

Availability of substitute:

If there is availability of substitute of a good then the demand of primary good is elastic and vice-versa. It is because as the number of substitute goods increases then consumer has more options to shift the demand to other substitute good. For example, Pepsi has may substitute goods thus, its demand is

relatively elastic.

Alternative use of good:

If any commodity has alternative uses then the demand of that commodity is relatively price elastic and vice-versa. For example, milk has alternative uses thus; its demand is relatively elastic.

2.

Elastic or inelastic:

Bottled Water:

Its demand is relatively price elastic as there is alternate option of water which is plentiful in supply and it is free practically.

Gourmet Coffee:

There are different varieties of the coffee available in the market which means gourmet coffee has number of substitute available. Thus, its demand is relatively elastic.

Apple Cell Phone:

Apple cell phones are inelastic as it does not have its substitute in the market. This is unique good in the market as it has unique operating system.

Gasoline:

Gasoline is necessary good and it does not have its substitutes. Thus, its demand is relatively inelastic.

3.

The necessary goods are those goods without which life is not possible. For example, water, food, housing etc. Its demand is relatively inelastic. On the other hand, the luxury goods have relatively elastic demand, its demand increases more proportionally than increase in income of the consumer. The bottled water, air condition, jewelry etc. are example of luxury goods.

4.

There is negative relationship between price of the good and its total revenue when demand price elastic.

There is positive relationship between price of the good and its total revenue when demand price inelastic.

There is no relationship between price and its total revenue when demand is unitary elastic.

The price elasticity of demand is most important to the pricing rule of firm. The elasticity suggests the direction of the change in to increase the total revenue. For example: if demand is relatively elastic then the reduction in price will increase the demand of the good.