Cross elasticity of demand Essay
Cross elasticity of demand
A. Discuss elasticity of demand as it pertains to elastic, unit, and inelastic demand.
Elasticity of demand is gauged by the percentage of change in demand when the price of an item varies. If the change in the quantity demanded is greater than 1 the demand is elastic. Elasticity of demand is calculated by ED=quantity demanded/decrease in price. If you reduce the price of milk by 6%, and that causes an increase of quantity demanded by 9% the demand for milk is elastic (ED= .09/.06 = 1.5).
Unit elasticity is when the change in demand for an item is equal to the change in price. In this example the price of milk is reduced by 3% which in turn results in an increase of demand by 3% t.
When the change in price percent is less than the change in demand percent, this is referred to as inelasticity. For this example, let’s say we have a 6% reduction in the price of bread but it only increases the demand by 3%.
B. Discuss cross price elasticity as it pertains to substitute goods and complementary goods. Cross-price elasticity measures the responsiveness of the demand for a good to a change in the price of another good. When measuring the cross price elasticity, the coefficient can be either negative or positive (McConnell, 2012). Substitute Goods is a positive cross elasticity. When similar manufactured goods move in the same direction when there is a change in price. Let’s compare iPads and Tablets, when the price of the iPads increases, the demand for Tablets increases.
Complementary Goods are negative cross elasticity. This happens when products move in the opposite direction as the sales of another product. An example of this would be laser printer and ink cartridges. When the price of printers decreases, the demand for ink cartridges would increase. The larger the negative cross-price elasticity confident, the greater is the complementarity between the two goods.
C. Discuss income elasticity as it pertains to inferior goods and to normal goods (sometimes also called superior goods).
Income Elasticity calculates the relationship between changes in the quantity demanded and the change of income. Normal Goods are products that are better quality, such as Name Brand clothing. When the consumers’ income increases, the demand for Name Brands increases. When the consumers income decreases, they are forced to revert back to Inferior goods, such as discount clothing stores, Good Will, or second had thrift stores.
D. Use an example to discuss why demand tends to be relatively elastic in a situation where “Availability of Substitutes” exists. The demand of a manufactured good that has close substitutes is more elastic because the consumers could easily choose the available substitutes when the price of the good increase. If the price of Doritos increases, the consumer can substitute Tortilla chips. This would mean that the Doritos is elastic.
E. Discuss the “Proportion of Income Devoted to a Good” concept by contrasting two products typically purchased each month. 1.Address, in your discussion, specific examples of how the same percentage change in the price of both goods affects the percentage change in the quantity demanded for each of the two goods. As proportion of income devoted to goods increases, elasticity increase.
Housing is essential, but when the price of owning their own home is too high; the alternatives may include renting or living with friends or family. Due to foreclosures because of the mortgage crisis, national home prices fell, but the demand for homes remained low. In contrast, if the cost of electricity increases, the product is inelastic. This is due to the fact that our daily existence depends on it for cooking, staying warm, and security.
F. Contrast how a person would initially respond to a relatively large increase in the price of a product in the short run as opposed to how that same person might react to that same price increase over a longer time horizon (i.e., the long run), using the “Consumer’s Time Horizon” concept.
When there is a large increase in the price of a product in the short run it results in inelastic demand because there is little time to adjust to the increase and find an alternative product. Let’s say the consumer uses the local bus service to go to work. On the way to work one day he notices that the prices of transportation will double beginning tomorrow.
In the short time he may be forced to continue paying the higher prices until he can find alternative transportation. As time passes, the consumer can make alternative choices such as carpooling, working from home, or riding a bike to work; therefore, the cost increase for the transportation would be elastic.
G. Identify by price range the areas on the demand curve where demand is elastic, inelastic, and unit elastic using the attached “Graphs for Elasticity of Demand, Total Revenue.”
1.Explain the corresponding impact on total revenue for each of the three price ranges identified in part G. The Demand unit elastic occurs at the production of 4 units at a price of $50.00 because neither Quantity nor Price have a dominant effect and the change in the price still produces the same amount of revenue. When the price is above $50.00, demand is elastic and revenue increases. When the price is below $50.00, the demand is inelastic and revenue decreases.
At the production level of 4-5, the company reaches its maximum total revenue. The price per unit will be $50. When the company produces one to four units, the demand increases as the price is decreased but after the 5th unit, the output does not reap additional revenue.