Distinguish Between Price Elasticity of Demand, Cross Elasticity of Demand and Income Elasticity of Demand. What Actions Might Be Taken by Countries and Companies to Reduce or Limit Price Fluctuations?

Topics: Supply and demand, Price elasticity of demand, Consumer theory Pages: 7 (2186 words) Published: December 2, 2012
Title: Distinguish between price elasticity of demand, cross elasticity of demand and income elasticity of demand. What actions might be taken by countries and companies to reduce or limit price fluctuations? Class: Business J

Student: Ibrokhim Parviz
Student ID: 99592
Tutor name: Sally
Word account:

Nowadays in modern developed market change in prices and other factors are very expected. The change in one of the factors for instance price and effect of it on another factor like demand or supply are measured by elasticity. Elasticity is the measure of how the change in one of the factor will be affected on the other factors. Elasticity measures extent to which demand will change. Measure easily can be calculated in percentage (Anderton 2008). After a calculation of elasticity, it’s divided into three types which are classified by values of elasticity: perfectly elastic-infinity; elastic - if value is greater than one; perfectly inelastic- equals zero; inelastic - if the value of elasticity less than one; unitary elasticity - if the value is exactly one (Anderton 2008). There are four basic types of elasticity measure: Price elasticity of demand; Income elasticity of demand; Cross elasticity of demand and Price elasticity of supply. In this essay will be discussed types of elasticity and government intervention in the open market, benefits and negative impacts (Anderton 2008). Note: New quantity demanded – ^Q; New price – ^P; Original Demand – Q; Original Price – P; Percentage change in quantity demanded-%Q; Percentage change in quantity of supply-%S; Percentage change in Price-%P Formula: P (times) ^Q (over) Q (times) ^P

Price Elasticity of Demand:
Price Elasticity of Demand or also known as Own Price Elasticity of Demand (PED), measures the responsiveness of change in quantity demanded to change in price. The formula is: percentage change in quantity demanded over the percentage change in price. PED has – (negative) sign in front of it; because as price rises demand falls and vice-versa (inverse relationship between price and demand). Determinants of PED are the availability of substitutes and time. PED have some links with changes in total expenditure (Anderton 2008). Example: After increasing price from P1 to P percentage change in price was 10, demand for good X is decreased from Q1 to Q and percentage change in quantity demanded is 60, what is price elasticity of this good? Solution: Formula is %Q / %D, so 60/10=6. PED is greater than one so its elastic good. Elastic demand curve of the Good X



0 Q Q1 Quantity

Income Elasticity of Demand:
Changes in real income of individuals can change the spending pattern of consumers. For instance if the consumer use to buy ketchup made by supermarket which is Normal good, after the increasing of income he can buy a Heinz ketchup so, Heinz will come as normal good, and the ketchup of supermarket production will be inferior good (Anderton 2008). This change measured by Income Elasticity of Demand (Anderton 2008). The formula is percentage change in quantity demanded over percentage change in income. If the answer will be positive sign it means its normal good; if negative sign, inferior good. Difference between inferior good and normal is by their income elasticity of demand. For instance holidays and recreational activities are with high income elasticity of demand, whereas washing up liquid have a low income elasticity of demand. If the value of income elasticity is lies between +1 and -1 so its inelastic. If it greater +1 or less than -1 so it is elastic. Example: Demand for housing increase by 10 per cent, simultaneous income of consumers rises by 5 per cent. Calculate income elasticity of demand. Solution: Formula is percentage change in quantity demanded over percentage change in income, so 10/5 = 2. The value of income elasticity of demand is greater than one,...

Bibliography: Anderton, A (2008). Economics Fifth Edition AQA. 5th ed. Essex: Pearson education. P30-132.
McDowell, M. (2012). Economics. London: McGraw-Hill Higher Education. p45-62.
Parkin M. (2010). Economics. 9th ed. US: Pearson. p56-60.
Sloman, J. (2006). Economics. 6th ed. London: Financial Times Prentice Hall. p89-104.
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