# Price Elasticity of Demand

Pages: 7 (1617 words) Published: May 3, 2009
Assignment 2

Price Elasticity Of Demand

Price Elasticity of Demand is the quantitative measure of consumer behavior whereby there is indication of response of quantity demanded for a product or service to change in price of the good or service ( Mankiw,2007). The Price Elasticity of Demand is calculated using either the point method or the midpoint method.

The Point Method

Price Elasticity of Demand=Percentage change of Quantity Demanded

Percentage change of Price

The Midpoint Method

Price Elasticity of Demand=(Q2 ' Q1) \ [ (Q2 + Q1)/2]

(P2 ' P1) \ [ (P2 + P1)/2]

Were:

Q1= initial Quantity Demanded

Q2 = new Quantity Demanded

P1=Initial Price

P2= new Price

(Source : Mankiw 2007)

A good or service can either be elastic, inelastic or unit elastic. When the price elasticity of demand of a commodity is elastic this is when the quantity demanded of a good or service responds significantly to the increase or decrease in price. Therefore after calculation the answer is greater than one making it elastic which means that increase in price decreases quantity demanded which in turn causes a decrease in total revenue because the decrease in quantity demanded will be proportionally larger than the increase in price. (Mankiw, 2007).

The good or service has either relatively elastic demand ( diagram (d) ) or perfectly elastic demand ( diagram (a) ). The difference of these two is that perfectly elastic has a Price Elasticity of Demand of infinity and this means that a small change in price would lead to an infinitively large increase in demand and this is shown in the diagram below (http://ecoteacher.asn.au/Demand/elastsli/e14.htm, n.d). While on the other hand Relative Elastic Demand is when the Price Elasticity of Demand is more than one and this shown in the diagram (d).

Perfectly Elastic Demand

(a)[pic]( Source : http://ecoteacher.asn.au/Demand/elastsli/e14.htm,n.d)

Perfectly Inelastic Demand

[pic]

Source: http://ecoteacher.asn.au/Demand/elastsli/e15.htm, n.d) (b)

Inelastic Demand , Elastic Demand and Unit Elastic Demand

Source: ( Welker’s Wikinomics Page -http://welkerswikinomics.wetpaint.com/page/Price+Elasticity+of+Demand, n.d)

[pic]

(c)(d)(e)

When a good or service is said to be inelastic after calculation it is less than 1. This is whereby an increase in price leads to an increase in total revenue because the price increase is proportionally larger than the decrease in quantity demanded (Hakes 2007). There is relative inelasticity of demand ( diagram (c) ) and perfectly inelasticity of demand were a good is demanded regardless of its price and the demand curve is vertical diagram (b) .

When a good is said to be Unit Elastic (diagram (e) ) after calculation the outcome 0. This whereby change in price has no impact on total revenue because the increase in price is proportionally equal to decrease in quantity demanded (Hakes, 2007).

Price Elasticity of Cigarettes

The demand for an addictive good like cigarettes is likely to be relatively inelastic while the demand for specific brands of cigarettes is likely to be relatively elastic. Governments usually impose ‘Sin Tax” on goods like cigarettes and this means consumers have to pay higher prices. This in turn leads to a decrease in sales but the price elasticity remains inelastic because cigarettes contain an addictive substance therefore consumers will keep on purchasing to suit their cravings.

In Taiwan the government imposed taxes on cigarettes in 2002 in order to reduce consumption and to reduce the health problems caused by cigarettes which were putting strain on the government’s health system (Lee, Hwang, Ye and Chen, 2004). This led to reduced overall consumption and increased tax revenues but the price elasticity remained inelastic at 0.5274 and even after estimations for 2003 were made after further...