Study on Managerial Economics

1MANEGERIAL ECONOMICS
MANEGERIAL ECONOMICS
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2MANEGERIAL ECONOMICS
Price elasticity of demand is important concept driving the demand theory in microeconomics. It
is the mechanism to capture the degree of responses the consumers make for any changes in
price. The genera law of demand explains that for decrease in price, quantity demanded would
rise and vice-versa as the lower price enhances the purchasing power of consumer leading them
to purchase more. Now for one unit increase in price, how much the demand would fall that
extend is reflected through elasticity. For negative relation between price and demand, the
elasticity contains negative sign with exception in cases like demand for Giffen goods that has
positive relation between price and quantity. Elasticity is defined as:
Ed = % change∈quantiy demanded
% change∈ price
Depending on the value of E the type of elasticity can be explained. If E<1, then it implies less
than one unit change in demand for unit change in price referring to inelastic demand. E=0 when
percentage change in quantity demanded is zero for one unit increase in price. This is called
perfectly inelastic demand. For E=1, the quantity demand rises just by 1 unit for unit fall in price.
This is called unitary elastic demand. E>1 implies to more than one unit change in quantity
demand for one unit change in price. This leads to elastic demand.
Price elasticity of demand is dependent on many other factors as well apart from price level only.
The important determiners are the substitutes of the goods an d the level of closeness or
integrated they are. The more closely the goods are related the greater the price elasticity. This
idea is better explained by the concept of cross price elasticity that captures the percentage
change in demand of related goods for one unit price change of any good. If the goods are
compliment to each other like tea and sugar, then increase in price of sugar will make the
demand for sugar fall. Since tea uses sugar, the demand for tea will fall too. On the other hand

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for substitute goods like tea and coffee, unit rise in price of coffee will make the demand for it to
fall and people would switch toward tea as preferred hot beverage. The availability of greater
number of substitutes allows people to switch between goods that further leads to greater extend
of substitution effect of price rise. The cross price elasticity is defined as:
Ed = % change∈quantiy demanded of good y
% change∈ price of good x
For 1 unit fall in price of x, if the demand for y rise then negative cross price elasticity takes
place in case of compliment goods and positive elasticity if x’s price hike increases the demand
for y evident in case or substitutes
Income is another important factor that determines elasticity of demand. Higher proportion of
income spent on goods has elastic demand that is for one unit change is price, the demand falls
more than one unit as people cut back on their consumption. The income effect is operative here.
Compared to that the income is spent in less proportion on the necessary goods like salt that has
low price elastic. Even if price changes in greater extent, the necessary good consumed in limited
amount is purchased anyhow without many changes in the demand. This reflects the fact that for
inelastic goods income effect is lesser too. Time also influences price elasticity as consumers
take time to fit in to the effect of price change. Longer time involved makes the demand elastic.
Income elasticity of demand is the concept that captures the changes in demand as result of
percentage changes in income. It is defined as:
Ed = % change∈quantiy demanded
% change∈income

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In determining the nature of future market for any product, income elasticity plays important
role. Higher income elasticity indicates possibility of expanded sales in face of rising income and
fall drastically in face of recession.
The factors influencing income elasticity is the degree of necessity. Demand for luxury goods
like cars, jewellery is elastic and the necessary goods like bread, rice have inelastic demand. This
results into higher and lower income inequalities subsequently. As income rise demand for
inferior goods fall as people move to better consumption like cheap margarine to high quality of
margarine. This makes the income elasticity negative too.
The income level of people determines the income elasticity. The poor have greater income
elasticity compared to the rich who has much lower income elasticity. The rate of satisfaction
also influences income elasticity. The greater the rate of satisfaction less is the income elasticity
due to lower changes in demand even if income rises.
The cross price elasticity helps in assessing the impact of rivals’ strategy of price in business on
own product.
Railway transportation in UK is inelastic as small rise in ticket price won’t impact the demand of
travelling through train. The reason is that very less amount of income is spent on the
train fare which is a necessary service having no faster substitute. The less proportion of
income used up to buy train tickets allows affordability without problem when substantial
rise in ticket price takes place. With rising national income affordability of people
towards cars increases, that reduces the rail transport demand. However, in short run and
daily affairs opting railways even if the fare goes up is appropriate because any other
transportation needs investment. Car suits the long run impact of demand due to change

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in fare and buying car seems to be appropriate and cheaper. However, a greater hike in
rail fare might exert different impact favoring the demand shift toward cars that matches
the cost of transportation.
Railway transportation in UK is inelastic as small rise in ticket price won’t impact the demand of
travelling through train. The reason is that very less amount of income is spent on the train fare
which is a necessary service having no faster substitute. The less proportion of income used up to
buy train tickets allows affordability without problem when substantial rise in ticket price takes
place. With rising national income affordability of people towards cars increases, that reduces
the rail transport demand. However, in short run and daily affairs opting railways even if the fare
goes up is appropriate because any other transportation needs investment. The travelling by
coach is not apt for daily journeys but might be good option to go for trip or long journeys or
visits to museum etc. In a group of commuters, it might be experienced that hiring coach with
collective contribution is lesser than the rail fare expenses making people avail the coach instead
of rail. Car suits the long run impact of demand due to change in fare and buying car seems to be
appropriate and cheaper. However, a greater hike in rail fare might exert different impact
favoring the demand shift toward cars that matches the cost of transportation. As the cross
elasticity of rail and coach fluctuate based on location. Without limiting the choice of
transportation, it is viable to use car since beginning. The income elasticity of coach being high
drives out income for slight increase in fare. Compared to the railroad, the road network
extended through larger expanse of land. This makes travelling by coach as one of the alternative
to the travelling by car. This leads to cross price elasticity of demand for travelling by coaches to
be zero as opting for car is not a viable option. However, the places that are served by both rail
and road networks the demand for coach travel is pretty higher in the face of making lesser sense

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financially. The reason behind such is the preference of commuters to avail a private coach to
travel with known people against the option of travelling in public transport. Another reason
behind making such preference is that coach will reach commuters to exact destination which a
train wont be able to do apart from taking people to station and let them set their own journey.

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