Academic Master

# Elasticity and its Application

Question 1

The term elasticity in economics refers to subject of change. Therefore, price elasticity of demand gives a definite picture of the change in the quantity of commodities demanded by individuals or organizations subject to the changes in prices of the commodities purchased.

The concept reflects how the price changes can affect the purchasing power of people or organization. If the change is a downward change then the quantity would increase and if the change is an upward change then the quantity would increase. Such a change reflects the purchasing power.

To calculate the price elasticity of demand, we consider the change in both the quantity demanded and the change realized on the price of the commodity. That is to say, change in quantity demanded at any point in time divided by the change in the price of the commodities.

Question 2

Income elasticity of demand refers to how the change in the quantity demanded responds to the change in the income of individuals at any particular point in time.

The concept implies that the demand of commodities will be high when the income is high and the quantity would decrease when the income is reduced.

The concept considers both the quantity demanded and the income to calculate the ratio. Therefore, to obtain the income elasticity of demand the change in quantity demanded is divided by the change in income.

Question 3

The concept captures two different commodities in its application. Hence, it measures the reaction of one type of commodity when its price is changed to another type of good. In other words, how the change in price of one good can affect the demand of another item (Fuchs, 1965).

The concept shows the impact of changing the price of a commodity on another commodity. If the price is changed upwards or downwards, what impact will it have on the other commodities?

Calculating the cross elasticity of demand requires incorporating the change in quantity demanded of a given commodity with a change in the price of another good.

Question 4

Total revenue refers to the gross receipts from the sale of goods or an item. In other words, it is considered as the total sales in shillings.

Calculating the revenue will require the presence of two variables, price and the sales volume. Therefore, total revenue is the product of the price and the quantity sold. If the total cost is deducted from the total revenue, then the company can easily measure its position. The profit indicates the company’s ability to give a return in excess of the expenditure. The revenue is determined by the quantity sold and the price of the commodity. Meaning the more the sales the higher the revenue and the lower the quantity sold the lesser the revenue.

Question 5

Elasticity refers to the response of a given economic variable to changes in other variables. For example, the response of quantity demanded when there is a change in the price of a good. Therefore, the variable changes proportionately with another variable. When the prices of commodities change proportionately with the quantity, the revenue is expected to respond accordingly with the changes (Andreyeva, Long, & Brownell, 2010).

Inelastic refers to the variables that decrease with less than proportionate in respect to other variables. There total revenue would decreases or increase with a value less than one.

Unitary elasticity refers to a change experienced in one factor which causes an equal change in another factor. Therefore in case of an increase in the price will lead to proportionate increase in revenue.

Question 6

The graph below represents the plotting of quantity against the prices of the commodity. It shows the changes on demand that occur when the prices of commodities are increased. The equilibrium price and quantity is also reflected by the graph. The graph indicates that as the price of the commodities increase the quantity decreases. The customers may shift the demand to substitute goods due to their reduced purchasing power. As observed from the table, the price is higher at 6 dollars while the quantity is at 1 dollar. When the price is reduced to four dollars the quantity demanded is at maximum. It implies that the demand of the customers is influenced by the prices of the commodities. In other words, the lower the prices of a good the higher the quantity purchased or sold. Therefore, a company can use the tactic of lowering prices to attract more customers to purchase the products.

Question 7 and 8The graph clearly indicates the effect of increasing price on the quantity of commodities.

Figure 1: The Demand Schedule for Barbeque Dinners

 Price Quantity Demanded Total Revenue Elasticity Coefficient Elastic or Inelastic 4 100 _____400_____ XXXX XXXX 6 80 ____480____ _____0.55_____ __elastic______ 8 60 ___480___ _____-1_____ ____inelastic______ 10 40 ____ 400______ _____-1.8_____ ____inelastic______ 12 20 _____240_____ ____-3.7____ _inelastic___ 14 1 ___14____ _____-11.8____ inelastic

To calculate the revenue, we multiply the demand with the price of the commodities. Therefore, the total revenue considers the values presented in the first two columns as indicated above.

The elasticity coefficient is as a result of using the midpoint formula. As a result the values are as an average of considered as the midpoint. We consider the change in the prices and the changes in the quantity. In other words, we divided the change in quantity with the change in price. The results are interpreted in the table to show whether it is elastic or inelastic. If the figure obtained is a positive it indicates that it is elastic. Where the figure indicated in the table is negative it becomes inelastic.

Question 9

Since the percentage changes have been computed then we only substitute the values in the formulas to obtain the income elasticity of demand.

The income elasticity of demand is computed using the formula below.

Percentage change in demand divided by percentage change in income

8%/10% = 0.8

Since the income elasticity of demand is less than one then it is a necessity good. Therefore, to the company there is a high demand for the good. Hence, the revenue generated is high. The basic commodity is required by people and they will always opt to purchase the commodity rather than purchasing luxury items. It means that the demand for the product will be constant or increase, or decrease if a competitor offering the same product will come into existence.

Question 10

The cross-elasticity of demand is obtained by dividing the percentage change in demand with the percentage change in price of the commodity.

8%/5% = 1.6

Since the cross-elasticity of demand is positive value then the goods are substitute goods. A substitute good means that it is a good that is available as an alternative to the customer. Once they fail to locate the commodity they need, they always think of another commodity that will act as a substitute. Hence goods A and B available are substitute goods.

#### References

Andreyeva, T., Long, M. W., & Brownell, K. D. (2010). The impact of food prices on consumption: a systematic review of research on the price elasticity of demand for food. American journal of public health, 100(2), 216-222.

Fuchs, V. R. (1965). Income elasticity of demand. In The Growing Importance of the Service Industries (pp. 8-12). NBER.

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