Price elasticity of Demand

Question: Discuss about the Price Elasticity of Demand. Answer: Demand and supply helps in analysing the mechanism in which market works. It helps in achieving the equilibrium state where the goods and services are produced and sold based on the decisions taken by the two phenomenons. In accordance with the demand and supply conditions, elasticity plays a major role in determining the effectiveness of the law of demand and supply (Rader, 2014). This report deals with the analysis of elasticity of demand. According to the law of demand, quantity demanded of a product decreases with an increase in price and increases with a decrease in price. Elasticity if demand helps in analysing the effectiveness of the change in quantity demanded with respect to change in price. It measures the magnitude of the change in quantity with the change in demand of the product (Nicholson Snyder, 2014). The aim of this report is to utilise the concept of elasticity of demand in explaining some real world examples. In order to do so, two articles have been chosen. One of the articles deals with the issue of housing prices and the other deals with comparison of change in demand for tobacco in developed and developing countries with the imposition of tax. In order to analyse both the cases, two different economic explanations has been provided which would help in understanding the concept of elasticity of demand with a better overview. Article 1 According to the news article published by the globe and mail on 13th march,2017, there has been a rise in the price of the houses in Toronto, not because of the shortage in the supply of houses, but due t the future expectations of the further rise in prices. According to josh Gordon, professor of Simon Fraser University, the rate of construction of the new houses and condominium units has been able to keep the pace with the rise in the population of the country; hence, there is a shortage in the supply of houses. It has been stated that the pre-existing homes in Toronto has not been able to come up for sale so far in the same volume as it has been in the past. Owners are waiting for the prices to soar up more in order to sell their houses, hence, new houses are being built in order to overcome the existing rise in demand. The expectation of future houses are being held as the major factor leading to further rise in the housing prices (Mail, 2017). According to the elasticity of demand, an effective change in the quantity demanded of the product due to the change in its price could be measured. Depending upon the type of good, being eth normal, luxury, inferior or necessity in nature, the elasticity of the product could range from zero to infinity (Rios, McConnell Brue, 2013). Houses are considered as luxury goods. With the expectation of the further rise in the Price of luxury product, it could be settled that the current price is considered lesser than the future process. Hence, with an elasticity of the product being greater than one, it could be stated that at the current prices of the houses, the change in the quantity demanded would be quite greater. This could be explained with the help of figure 1, below. Figure 1: Elasticity of Demand for Houses (Source: As Created By the Author) In figure 1, the relatively elastic in nature. A relatively elastic demand curve is flatter as drawn in the diagram and is market d. Let the price for future expectation be p1 and current price be p2. It could be seen that the corresponding demand for p1 is q1 and that of p2 is q2. As the elasticity of demand is more than one in this case, it could be seen that the difference between the changes in price is lesser than that of the magnitude of change in quantity demanded. Hence, it could be stated that with a slight expectation of a raise in price of the houses in future leads to a massive rise in the quantity demanded for the houses at the present state. Article 2 An article posted by tech featured on 30th January 2017, deals with the comparison of price elasticity of demand for tobacco in developed and developing countries. In this article it has been stated that the impact of tax on tobacco would raise the price of tobacco in the countries. Yet, the effect of change in the price of tobacco has not been able to generate similar responses in the change in quantity ended. With an increase in the price of tobacco there has been a higher fall in the quantity demanded of the product in developing countries than in the developed countries ("Price Elasticity Of Demand And Tax On Tobacco - Tech Featured", 2017). This could be explained with the aspect of elasticity of demand. Elasticity of demand measures the effectiveness of the change in quantity demand with respect to change in its price. A product which is less elastic for a group of people tends to show lesser change in the quantity demanded than with for the people who tends to be more elastic in nature (Acemoglu, Laibson List, 2017). In figure 2, there are two diagrams drawn. In the first one, the scenario if the developed countries has been taken into consideration whereas, the second part deals with the developing countries. The demand curve faced by the developed countries seems to be less elastic in nature than the demand curve for tobacco faced by the developing countries. In the case of developed countries when the price increase from p1 to p2, there is a slight fall in the downward for products from q1 to q2. Elasticity of demand for developed countries is less than one. In developing countries, ads the price of the product increase from p1 to p2, there is a considerable fall in the demand for tobacco from q1 to q2. This therefore shows that the elasticity for the demand of tobacco in such countries is more than 1. Both the scenario could be explained with the help of figure 2 below. Figure 2: Elasticity Of Demand For Air Travel (Source: As Created By The Author) Both the articles has been taken into consideration in order to frame the effect of elasticity of demand on real world examples. This helps in acknowledging the behaviour of the consumer depending upon the type of the goods. Whether the goods is considered as more elastic or less elastic in nature is completely dependent upon the consumers perspective. Real world example is considered to be more precise in analysing the elasticity of demand. Reference Acemoglu, D., Laibson, D., List, J. (2017).Microeconomics. Pearson. Mail, T. (2017). Demand fuels Toronto house prices, not lack of supply, study finds. The Globe and Mail. Retrieved 3 April 2017, from https://www.theglobeandmail.com/real-estate/toronto/demand-fuels-toronto-house-prices-not-lack-of-supply-study-finds/article34279980/ Nicholson, W., Snyder, C. (2014).Intermediate microeconomics and its application. Nelson Education. Price Elasticity Of Demand And Tax On Tobacco - Tech Featured. (2017). Tech Featured. Retrieved 3 April 2017, from https://techfeatured.com/5528/price-elasticity-of-demand-and-tax-on-tobacco Rader, T. (2014).Theory of microeconomics. Academic Press. Rios, M. C., McConnell, C. R., Brue, S. L. (2013).Economics: Principles, problems, and policies. McGraw-Hill. Price Elasticity of Demand Question: What is the Price Elasticity of Demand ? Answer : Introduction A model can be defined as a framework that allows an easier explanation of complex economic processes. While the models may be true, others are false. The difference between the two is explained by certain conditions that has to be fulfilled for a model to be termed as positive. According to Ouliaris (2017), the job of the modern economy of the allocation of limited resources and the distribution of output to many agents makes it a complex machine. The agents include the government, individuals and firms. The action of any of the agents have an influence on the others either directly or indirectly. He noted that economists of today build models that acts as roadmaps to reality that helps in the understanding of the operations of the modern economy. The statement about the economic models being false is not accurate. The government should therefore continue using them for future predictions. The argument is that, predictions through economic models have been in most cases be positive. They help in simplifying the interpretation of various economic predictions. Measurable signals are emitted by economies in their allocation of goods and services which is an indicator of drive to complexity. For instance, the growth of output has been used as an explanation for the growth of an economy which is true since its as a result of improved investment level and increased level of employment. The models of inflation shows that it has a negative relationship with the unemployment rate; this has empirically been tested to be true. Formal explanations are invited in the case of empirical regularities given that the economy is complex. Models are important for prediction as they give the theorys implications and infer the consequences of makin g various assumptions Odekon (2006). The inner working of the economy could be understood better if the economists and the policy makers learnt more on the various processes that result in various stylized facts. The economy could be directed towards achieving a more desirable outcome when such knowledge is applied in the future predictions. This may include issues like the avoidance of a global financial crisis. Bearing the fact that economic outcomes lack objective measures, economic models are made subjective in design which acts as a very important feature. The forms taken by economic models according to Dwivedi (2006) are either mathematical equations, graphs or logical statements. Odekon affirms that business firms, individuals and governments need economic prediction in the planning of their future course; this is facilitated by applying various models. Economic models are divided into two broad categories the theoretical and empirical models. The theoretical models analyses economic behaviors and derives verifiable implications with an assumption of objectives maximization given various constraints clearly explained in the model. The answers provided by the theoretical models to specific questions are qualitative such as ways of handling market failures. The aim of the empirical models in contrast is to verify the theoretical models qualitative predictions by converting them to precise numerical outcomes. For instance, when considering the behavior of an agents consumption, the theoretical model indication that the expenditure is positively related to the agents income. On the other hand, the empirical models does a deeper analysis and tells us facts like the extent by which expenditure changes when income rises by specified units. According to Carr-Hill Stern (1977), the relevancy of economic models is raised by the fact that th ey allows for additional of new variables which improves the accuracy of results. Economic behavior theory is described by an economic model through a mathematical equation set. Useful clues about the behavior of rational agents or rather the working of the economy is derived from the inclusion of many equations in the economic model. The economic models could either be simple or rather complex. A simple model is for example when you consider how the demand for a specific product is influenced by its price. The higher the price of that product, the lower its demand and vice versa. The complex models include for example the prediction of an economys real level of output. Lipsey Chrystal (2011) noted that a model is accurate since it is developed from real economic observations. The economic models are useful in the real world if they are based of accurate assumptions Dwivedi (2010). He also noted that the behaviors of agents tend to be similar which improve the accuracy of an economic model. Source: https://spot.colorado.edu/~kaplan/econ2010/section4/section4-main.html The figure above shows that products such as gasoline have a low price elasticity of demand. A rise in the price of gasoline from $1 to $1.10, is a 10% increase. The resulting fall in the quantity demand is very little; from 20 to 19 gallons, its a 5% decrease. The result of dividing the % change in quantity demanded and the % change in price is 0.5. This is observed in the short run. In 2016, the PED for gasoline was -0.26 (Moffatt, 2016). This is a small magnitude of responsiveness. Source: https://spot.colorado.edu/~kaplan/econ2010/section4/section4-main.html The figure above shows that products such as sodas have an elastic price elasticity of demand. A rise in the price of six-pack sodas from $2 to $2.20, is a 10% increase. The resulting fall in the quantity demand is very little; from 1000 to 850 gallons, its a 15% decrease. The result of dividing the % change in quantity demanded and the % change in price is 1.5. The PED for a six-pack soda is relatively elastic (Kaplan, 2002). In 2015, the PED for soft drinks was 1.06 and that for sugar-sweetened beverages was 1.16 (Colchero, et al., 2015). This is a greater magnitude. In 2016, the PED for apples was -0.58 (usda.gov, 2016). This is a small magnitude owing to the fact that the substitutes to fruits are so many. References Carr-Hill, R. Stern, N. (1977). Theory and Estimation in Models of Crime and its Social Control and their Relations to Concepts of Social Output. Colchero, M., Salgado, J., Unar-Munguia, M., Hernerndez-Avila, M., Rivera-Dommarco, J. (2015). Price elasticity of the demand for sugar sweetened beverages and soft drinks in Mexico. Sciencedirect.com. Retrieved 15 March 2017, from https://www.sciencedirect.com/science/article/pii/S1570677X15000611 Dwivedi, D. (2006). Microeconomics: Theory and applications. New Delhi: Pearson Education. Dwivedi, D. (2010). Macroeconomics: Theory and policy. New Delhi: Tata McGraw Hill Education Pte Ltd. Kaplan, J. (2002). Principles of Microeconomics: Section 4 Main. Spot.colorado.edu. Retrieved 15 March 2017, from https://spot.colorado.edu/~kaplan/econ2010/section4/section4-main.html Moffatt, M. (2017). Would a Gasoline Tax Cause People to Buy Less Gas?. ThoughtCo. Retrieved 15 March 2017, from https://www.thoughtco.com/price-elasticity-of-demand-for-gasoline-1147841 Lipsey, R. Chrystal, K. (2011). Economics. Oxford: Oxford University Press. Ouliaris, S. (2017). Economic Models: Simulations of Reality. Imf.org. Retrieved 14 March 2017, from https://www.imf.org/external/pubs/ft/fandd/basics/models.htm Odekon, M. (2006). Encyclopedia of world poverty. Thousand Oaks, Calif: SAGE Publications. usda.gov. (2016). USDA ERS - Food Demand Analysis. Ers.usda.gov. Retrieved 15 March 2017, from https://www.ers.usda.gov/topics/food-choices-health/food-consumption-demand/food-demand-analysis/