Elasticity free essay sample

Elasticity of demand is the measure of consumer response to a change whether an increase or decrease in price. There are three categories that the response of the consumer can be grouped into: elastic, inelastic and unit elasticity. The calculation is relatively simple and the answer or the coefficient will be compared to the number 1. This number will always be positive and if our calculation gives us a negative number we take the absolute value. We divide the percent of change in demand by the percent change in price. For example if the price of milk went up 10 % and the change in demand went down by 1% we would divide . 10 by . 01. This would give us an answer of . 1. Given that . 1 is less than 1 we know that the good, in this case milk, would be inelastic. This means that over the short run price does not have a high impact on demand. If we were to look at a different good or service we may see different results. We will write a custom essay sample on Elasticity or any similar topic specifically for you Do Not WasteYour Time HIRE WRITER Only 13.90 / page For example if the price of movie tickets increased by 10% and the demand decreased by 20% we would apply the same calculation. We would need to divide . 20 by . 1 which would give us a coefficient of 2. 2 is greater than 1 so we can say that this good falls into the category of being elastic. Although rare the third category that a good or service can fall into is called unit elasticity. Unit elasticity is when the percent change in price is equal to the percent change in demand. For example if the cost of books increased by 10 percent and the demand decreased by 10 percent then when we divided . 1 by. 1 we would get an answer of 1. When this happens we know that this item has unit elasticity. B. Cross price elasticity helps us determine the relationship between two different products. We calculate this by dividing the percent change in demand for product Y by the percent change of price in product X. This calculation will help us identify whether the products are substitute or complementary goods. Unlike our calculation for Elasticity of demand we compare our answer here to the number zero. We use both positive and negative numbers. If we were to compare movie tickets which had a 5 percent increase in price to popcorn which had a 10 % decrease in demand we would calculate this by dividing . 05 by -. 1 we get an answer of -2. This of course is less than zero so we know that these two products are categorized as complementary. C. Income elasticity is the measure of demand changes in comparison with the change in personal income. This will help us categorize products into two categories inferior and superior goods. This is also measure up against zero and allows for both positive and negative values. The calculation is done by dividing the percent change in demand of a specific product by the percent change in income. As an example if we were to see how consumers respond to a 10 percent increase in relation to demand for high definition televisions. If we were to suppose demand increased by 5 per cent we would calculate this by dividing . 05 by. 1 which would result in an answer of . 5. We know this item would be considered a normal or superior good since our answer is a positive number. If we were to look at the demand of DVD players in relation to a 10 percent increase in personal income and we have a 25 percent decrease in demand we would divide -. 25 by . 1 which would result in an answer of -2. 5. Since this number is less than zero we would categorize this product as an inferior good. D. Lets refer back to our earlier example using red and green grapes. When we performed our calculation we discovered â€Å"Availability of Substitutes† exists for red grapes. This means that there are options for substitutes that consumers find acceptable. If we go to Safe way and see that red grapes are 3 dollars more than green grapes it is reasonable to choose the green grapes. Since there are available substitutes that are easily accessible this keeps demand elastic E. â€Å"Proportion of Income Devoted to a Good† is a concept that looks at the percent of personal income that is dedicated to a particular good or service. We have been dealing with change in percentage so price can changes can appear equal but that can have significant impact depending on what the proportion of income is. F. For example each month I pay for my Netflix subscription. For this discussion let’s say it represents 1 percent of my income. I also pay 1600 dollars a month in rent each month. If both of these items were to experience a 10 percent price increase the impact would be very different. My Netflix would go from 10 to 12 dollars. This would be irritating but insignificant. My rent however, would go from 1600 to 1920 a month. This would be unsustainable for me to maintain. Over the short term I would more than likely have limited options such as first and last month saved etc. so I may get a roommate but over the long run I would have time to choose a more reasonably priced place to live that met my needs. Demand becomes more elastic over the long run because consumers have time to â€Å"shop around† and find other solutions. G. The price range the areas on the demand curve where demand is elastic is between $80 and $50 and the qty is between 1 and 4. The price range where the demand is unit elastic is between$50 and $40 and the qty is between 4 and 5. The area of the demand cure where demand is inelastic is between $40 and $0 dollars and the quantity is between 5 and 9. We can determine this one of two ways. First is by using the calculation we discussed earlier for elasticity of demand. Second would be to use the Total Revenue Test. When demand is elastic price will decrease while revenue increases. When demand is unit elastic price will decrease however revenue will remain the same. When demand becomes inelastic price will decrease as well as revenue.