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Study on Managerial Economics

   

Added on  2020-05-01

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1MANEGERIAL ECONOMICSMANEGERIAL ECONOMICSName of Student:Name of University:Author Note:

2MANEGERIAL ECONOMICSPrice 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∈quantiydemanded%change∈priceDepending 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

3MANEGERIAL ECONOMICSfor 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∈quantiydemandedofgoody%change∈priceofgoodxFor 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 substitutesIncome 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 limitedamount 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∈quantiydemanded%change∈income

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