Pages: 5 (1774 words) Published: May 10, 2013
Supply and Demand
Elasticity of Demand
Elasticity of demand is a variation in price depending on the demand of a good or service. Items like vehicles, appliances, jewelry, and electronics will sell less at full price than they do when there is a drop in price. When producers and retailers drop the price enough for the market to take notice, people react in deciding to purchase the good or service. This reaction and sensitivity to the market is known as Elastic demand. Unit Elasticity of Demand applies to single units of a good or service and occurs when a shift in price directly affects a product per unit. If the percentage of change in quantity divided by the percentage of change in price is one. Inelastic demand happens when the demand for an item does not change much based on price. Therefore inelastic demand is when the demand for a good or service does not change based on a variation in price. While theoretically if a price increases then less units are sold and if a price decreases more units are sold, if the price fluctuation and the percentage fluctuation of items sold are the same then there is no change to total revenue. If there is no change to total revenue then there is no benefit to trying to create a demand or shrink the market. (Wikipedia.com) Cross Price Elasticity

Cross price elasticity happens when the price increase or decrease of one item affects the demand increase or decrease of another item. These items are normally similar or interchangeable. An example would be if the price of butter goes up then the demand for margarine goes up. This form of elasticity can also happen with complementary goods. For instance, when the price of gasoline goes up the demand for purchasing trucks goes down. In a place where one lives and a need for travel by truck is necessary, there will be likelihood to repair before new purchase. Income Elasticity

Income elasticity is a way of measuring how people respond to their demand of a good or service when there is a fluctuation in their income. The theory of income elasticity is that the more income one has the more they will spend and will demand higher quality products known as superior goods. There is also a quantity change in the demand for what is considered “normal” necessities. An example would be purchasing a case instead of normal consumption of an item. Luxury items are still very susceptible to income change and an increase in income elasticity does not mean an increase in luxury items will occur. Income elasticity will be affected negatively with decrease to income. When one has less income, then the tolerance for lesser quality goods, inferior goods, increases. This is when substitutes, lower quality and lower quantity are experienced. When there is a slight change either way to one’s income, the elasticity will not deviate much either way. A person will continue with their normal spending habits with slightly higher demands. My example for this is the “blowing up blender”. As a single mother making barely more than poverty level, I could only afford a blender for \$19.99. I would normally buy two per year as they would “blow up”. As my income increased, I was able to purchase the \$29.99 model. That blender would last 8-9 months. With a greater increase, I splurged and bought the \$69.00 blender which I have enjoyed for more than a year! Substitutions

In a market where there is a plethora of substitutions, those substitutions create and sustain price elasticity. Any time there are sufficient substitutions, buyers have a wider range of choice and therefore create broader competition which can force price wars between producers. (investopedia.com) The soft drink market is an example of where substitutions are readily available and those substitutions regulate the prices for all soft drinks on the market. The manufacturing companies will often keep their prices with a range of their competitors to ensure that product loyalty will beat...

References: Price Elasticity of Demand, http://en.wikipedia.org/wiki/Price_elasticity_of_demand, Wikipedia
Economics Basics: Elasticity, http://www.investopedia.com/university/economics/economics4.asp#axzz2NBHpY7LD, Investopedia
The Time Horizon, http://www.mbs.edu/home/jgans/mecon/value/Popups/pop_up_time_horizon.htm, Melbourne Business School, Australia