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Elasticity Coefficient Economics Assignment
This is a solution of elasticity coefficient economics assignment helpin which we discuss elasticity of demand in economics.
(a) What do you understand by the following terms? Explain each term with a definition, formula, example and diagram.
(i). Own price elasticity of demand
Own price elasticity of demand defines the change in demand of goods with the change in price (Deaton, 1975).
Own price elasticity of demand= change in quantity demanded (%)/Change in price (%) (Hanushek, 1980).
Increase in price of Orange juice by 10% caused decrease in demand by 30% which means own price elasticity of demand of orange juice is -3.
This suggests that the demand for orange juice and price of orange juice are negatively related such that if the price increases the demand will fall down.
(ii). Cross price elasticity of demand
Defined as the change in demand of an item due to change in the price of another item (Bijmolt, 2005).
Cross price elasticity of demand= percentage change in the demand of item X/percentage change in price of item Y
Due to increase in price of coffee by 10% demand of tea is increased by 20% In this case the demand of coffee and price of tea are positively related as the demand increases of a product with the price increase of another product. (Check for more solutions: Economics Unit Assignment)
(iii) Own price elasticity of supply
It is a relation between the changes in quantity supplied to the change in price. It is one of the measures of elasticity which producers look at while trying to change the supply for an item.
Own price elasticity can be defined as elastic if it is more than 1 and the producer can increase the supply without much change in the price of the item whereas it is said to be inelastic if it is less than 1 which means changing the supply can result into more increase in the price of the item.
An elasticity of zero suggests that the quantity which can be supplied does not vary with the change in price.
Own price elasticity of supply= % change in the supply/% change in the price.
Increased price of ink by 10% resulted in the decrease in supply of ink pens by 15%. This helps us derive the price elasticity of supply as -1.5.
(b) What determines the sign (positive or negative) of the following coefficients? Give example in each case.
(i) Cross price elasticity of demand
Sign of the cross price elasticity of demand is determined by the change in the demand of an item with the price of another item.
RELATED ITEMS: If the items are related or component of one of them then the value of sign of the coefficient is negative e.g.Increase in price of fuel results in decrease in demand of cars.
SUBSTITUTES: If the items are substitutes of each other that the value of this coefficient is positive e.g. increase in price of tea results in increase in demand of coffee.
(ii) Income elasticity of demand
Sign of the income elasticity depends on the Necessity level of goods.
DAILY USE: Goods having normal necessity will have positive income elasticity(0 to +1) as the demand of such goods increases less than proportionally as the income level of consumer increases.
E.g. Daily basic needs toothpaste, soap etc.
LUXURY: goods having luxury necessity have a positive income elasticity of more than +1 as the demand for such goods rises more than proportionally as income rises.
E.g. Designer clothes, exotic vacations etc.
Inferior: Inferior goods or services have negative elasticity of less than 1 as the demand of these goods or services decreases as the income increases.
E.g. public transport to more luxurious private car.
- Consider the following information, produced by a market research agency, about the relationship between petrol and the demand for cars with low fuel economy. All the information relates to long term market adjustments.
- Own price elasticity of demand for the oil (-) 0.6
- Own price elasticity of demand for cars (-) 1.9
- Cross price elasticity of demand for petrol with respect to the price of cars is
- Income elasticity of demand for cars + 1.5
(a) Explain the relationship between petrol and cars with low fuel economy, using the concept of cross price elasticity of demand
Answers- As given the price elasticity of demand of petrol with increase in price of cars with low fuel economy is -4 which means if the price of cars increases by 10% then the demand of petrol decreases by 40% (Hancock, 1985).
The demand of petrol and price of cars are inversely related and is highly elastic which suggests that the demand of petrol will fall drastically if the price of car will have a minor increase. As far as the elasticity values are concerned the higher the value is higher is the elasticity or responsiveness to the change in price.
These goods are actually complements of each other and an inverse relationship exists between them (Perkins, 1977).
(b) Explain what would be the effect of a 20% increase in the income of the buyers of cars with low fuel economy on the demand for cars? What type of good is a car? Why?
Answer: As given the income elasticity of demand for cars is +1.5 which means if the income of the consumer increases by 10% then the demand of cars increases by 15%. The income of consumer and the demand of car are directly related and highly elastic.
1.5(coefficient of income elasticity) =20%/X
X= 15% (demand for cars)
Car is a luxury type of product as the coefficient of elasticity is more than +1. As the income of consumer increases the demand of the luxury good increases (Wilkinson, 1973). (see more information on: Macro economics assignment)
(c) Your firm’s accountant argues that, because the demand for the cars with low fuel economy is price elastic, the firm should drop its price by 10%. Briefly discuss this recommendation indicating if you would support this recommendation or not. Give reasons and a diagram for your advice to management and indicate what other information you would to examine before arriving at your recommendation?
Yes the demand of cars with fuel economy is price elastic as the demand reduces drastically with the increase in price.
In case the price of car is reduced by 10% the demand is expected to increase by 19% based on the own price elasticity of demand.
Factors to be analyzed:
- Substitutes: Competition due to cars available in the market in the same price range should be analyzed.
- Time: Time taken to meet the increased demand.
- Nature of the product: Car is a luxury product and hence demand may not go as high as expected as it is a capital intensive investment for the consumer. (4 marks)
Presentation and referencing (citations and reference list)(2 marks)
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