NATIONAL INSTITUTE OF BUSINESS MANAGEMENT
PRINCIPLES OF ECONOMICS
Master in Business Administration
Q. Suppose the price elasticity of demand for text books is two and the price of the text book is increased by 10%. By how much does the quantity demand fall? Inter the result and discuss reasons for the fall in quantity demand?
Elasticity is the ratio of the percent change in one variable to the percent change in another variable. It is the measure of the responsiveness of quantity demanded to a change in the price level of the product, a product may be perfectly elastic, perfect inelastic and unitary, when a good's elasticity is perfectly inelastic then a change in the price of the product will not change the amount demanded, a perfect elastic product is that which its demand will change by a large magnitude than the change in price. It is a tool for measuring the responsiveness of a function to changes in parameters in a relative way. An "elastic" good is one whose price elasticity of demand has a magnitude greater than one. Price elasticity is an important concept because it tells us how responsive the demand or supply will be to changes in price. If prices rise by 10% will the demand or supply fall or rise by less than 10% or more than 10% . It is important to businesses because it influences their behavior in terms of pricing strategies and the degree of market power they exercise. Some businesses are able to charge different prices for the same product at different times because the degree of elasticity is different. Elasticity has an important influence on the total revenue earned by the firm following changes in price and is therefore very important in analyzing the extent of the impact on a market as a result of a change in demand and supply conditions. We can see this clearly in the case of the increase in petrol duty - there are very few substitutes for petrol and as a result in the short term motorists and public carriers have very little choice but to pay the higher price - the influence on the level of demand therefore is going to be negligible. Knowledge of such concepts allows us to be able to offer an insight into government policy on this issue. If the government claim to be increasing petrol duty to influence behavior - i.e. get people out of their cars and onto alternative forms of transport, without at the same time investing heavily in those alternatives we might question their true motives. Free market gives the absolute power to prices to determine the allocation and distribution of goods and services. These prices, in turn, are fixed by the forces of supply and demand of a respective commodity. In cases of demand falling short of the supply of a respective commodity, the price will fall as opposed to a price rise when the supply is inadequate to meet the growing demand of a good or service. Free market economy is also characterized by free trade without any tariffs or subsidies imposed by the government. There the price mechanism solves all the problems of production. The price of any commodity in the market is determined by the general interaction of the forces of the demand and supply. Demand is the desire backed by ability and willingness to pay for a commodity. It generally means the desire or want for a thing. But in economics mere desire or want for a thing is not a demand. Only when the desire for a commodity is backed by the ability and willingness to pay for it the willingness became demand. A beggar may have a desire to own a motor car. But he has no means to purchase one. It is, therefore, a mere desire, and it is not demand. Similarly a miser may have the desire to have a sumptuous meal. He has the means too. But he is not willing to part with the money for the meal. If so, it is a mere desire, and it cannot be a demand. In short Demand is...
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