Microeconomic Analysis: Elasticity of Demand and Related Concepts

This economics assignment delves into the concept of elasticity, a fundamental principle in economics that measures the responsiveness of consumers and producers to changes in various factors. The assignment explores three key types of elasticity: elasticity of demand, income elasticity of demand, and cross elasticity. Elasticity of demand examines how changes in price affect the quantity demanded, providing crucial insights for producers' pricing decisions and the impact of taxes. Income elasticity of demand assesses how changes in income levels influence product demand, allowing both consumers and producers to anticipate shifts in demand based on economic conditions and categorize goods as normal or inferior. Cross elasticity analyzes the impact of changes in the price of one good on the demand for another, determining if goods are complements or substitutes. The assignment highlights the significance of elasticity in informed economic decision-making by both buyers and sellers, emphasizing its role in efficient resource allocation. The paper uses examples to explain the practical applications of elasticity in real-world scenarios and references relevant academic literature.

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A key concept in economics is elasticity which reflects the extent of change
which is observed amongst producers, consumers and individuals in terms of their
demand and supply on account of changes in various pivotal factors such as price,
income and other relevant parameters. There are various types of elasticities which
have relevance for the economic decisions by the various participants. A key
example in this regards is elasticity of demand which reflects the extent of change in
demand expected by changes in price (Mankiw, 2014). This is pivotal information for
the producers as it enables them to make pricing decisions. For instance, consider a
good or service which has an elasticity of demand of 2. This would imply that the
demand of the underlying product is elastic which would mean that the sellers would
be benefitted by keeping the price low as higher price would have adverse impact on
the overall revenue and profits (Arnold, 2015).
The elasticity of demand also has relevance for pricing when taxes are
imposed. This is because for goods having elastic demand, any tax imposed by the
government would have to be majorly borne by the producers as increasing the price
could have significant adverse impact on demand. This in turn would tend to limit the
supply which over the medium term would lead to an upward revision in price. On
the contrary, with regards to goods such as cigarettes which have inelastic demand,
a large portion of the tax burden could be passed on to the consumers since the
impact on demand would be minimal. Thus, the responsiveness of the consumers
and producers with regards to tax is highly driven by the elasticity of demand
(Besanko & Braeutigam, 2014).
Another type of elasticity which is relevant for economic decision making is
income elasticity of demand. This elasticity essentially highlights the response of
changes in income level to demand of products. Typically for luxury goods, the
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income elasticity is greater than 1 which would imply a disproportionate impact of
changes in income on the product demand. The buyers and sellers would use this
information in order to take economic decisions (Arnold, 2015). For instance, if a
luxury car maker expects the income level of the target audience to enhance in the
near future, then the producer would aim for enhanced production in wake of
expected pick up in demand. Similarly, a consumer in wake of an economic
downturn would postpone the decision to purchase a luxury item as it may get
cheaper in the near future (Mankiw, 2014).
The concept of income elasticity also enables the consumers and producers
to understand if the underlying product is inferior or not. For instance, if the demand
for the underlying product or service tends to decrease as there is an increase in the
income levels, then it would mean that the product is inferior. This is because for a
normal product the demand would be expected to increase as there is improvement
in income level of the consumers (Besanko & Braeutigam, 2014).
Another type of elasticity relevant for decision makers is cross elasticity. This
captures the impact of changes in price of a good on the demand of another good.
This parameter is significant since not only does it indicate the magnitude of impact
of price change but also reflects if the pair of goods is complementary or substitutes.
For instance, consider two products i.e. orange and orange juice. This pair of
products is complementary since both are inter-connected. If there is a shortage of
orange or disruption in the supply of orange, it would lead to increased price of
orange juice on account of incremental raw material cost. Through the concept of
cross elasticity demand, it is possible for the producers and consumers to respond to
developments which impact the demand supply of a particular product on both
complementary and substitute products. For instance, if Pepsi increases the price,
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then there would be an increased demand for Coca-Cola owing to the substitute
relationship between the two products (Arnold, 2014).
From the above discussion, it may be concluded that the concept of elasticity
is a very significant topic in economics as it determines the manner and extent of
responsiveness of the key market participants i.e. buyers and sellers. The key
economic decisions taken by the producer with regards to production both in terms
of price and quantity is dependent on the various elasticities and the changes in key
factors such as price and income. In order for efficient usage of limited resources, it
is imperative that these concepts are considered by both buyers and sellers.
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References
Arnold, A.R. (2015). Microeconomics (9thed.). Sydney: Cengage Learning.
Besanko, D. & Braeutigam, R. (2014).Microeconomics (4thed.). New York: John
Wiley & Sons.
Mankiw, G. (2014) Microeconomics (6thed.). London: Worth Publishers.
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