Elasticity: Consumer Theory and Demand

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Elasticity is a measure of how much buyers and sellers respond to changes in market conditions. There are 3 types of elasticity of demand, which are price elasticity of demand, income elasticity of demand and cross elasticity of demand. In general, elasticity of demand is important for a firm in price setting for its products.

Price elasticity of demand is the percentage change in quantity demanded given a percent change in the price. It is a measure of how much the quantity demanded of a good responds to a change in the price of that good. The formula of price elasticity of demand is price elasticity of demand = percentage change in the quantity demanded / percentage change in price. For an example, if the price of a cake increases from RM2.00 to RM2.20 and the amount of buyers fall from 10 to 8, price elasticity of demand is calculated as follow:

(10-8) / 2 x100 = 20%
__________________________ = 2
(2.20-2.00) / 2.00 x 100 = 10%

It is an elastic demand since the value of price elasticity is greater than 1. Percentage change in quantity demand is greater than percentage change in price. Product with elastic demand tends to have sensitive change in demand when the price changes. The marketer should not suggest to increasing the price of the cake because it will lead to a fall in revenue. As the price increase, the quantity demanded for the cake decrease and sales fall, thus pulling down the overall revenue of the shop. If the price elasticity of demand is less than one, percentage change in price is greater than percentage change in quantity demand. The shop should be more willing to increase the price of the cake when only it has an inelastic demand because it will lead to an overall increase in their revenue. With an increase in price of the product, demand will not fall and this end up in more revenue for the shop.

Income elasticity of demand is the percentage change in the quantity demanded divided by the percentage change in income. It...
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