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The price elasticity Essay

Explain the price elasticity of demand and its determinants which are; the availability of close substitutes, necessities vs. luxuries, the definition of the market, and the time horizon. For each of the four determinants give an example from everyday life. Price elasticity of demand measures the sensitivity of quantity demanded of a commodity to the change in the price of the same commodity. In other words, it is the percentage change in the quantity demanded by the percentage change in the price of the same commodity. The value is always less than equal to zero.

When the price elasticity is zero, the demand is said to be perfectly inelastic which means no matter what the change in price the quantity demanded remains the same. While the perfectly elastic value is -? , which means even for a negligible change in price, the quantity demanded changes manifold. The consumers will only pay a certain price or a narrow range of prices for the product. At the value 1, the demand is said to be unitary elastic which means for one percentage change in price, the quantity demanded changes by one percentage point.

There are many determinants of price elasticity, the major of them

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discussed below: • Availability of Close Substitutes-more the close substitutes available for a good, more is the price elasticity. If the price of the good changes even a little, there is a great impact on the quantity demanded for the same good. People can easily switch from one good to another if a minor price change is made. Let’s take the example of beverages, when the price of coffee rises; the consumers begin to drink more of tea, cold drinks or juices.

Similarly, if the price of coffee falls, the consumers may shift to coffee. • Necessities versus luxuries- The more necessary a good is, the lower the elasticity, as people will attempt to buy it no matter the price, such as the case of insulin for those that need it. The demand for luxuries tends to be more elastic. People may postpone or altogether refuse to buy a luxury if its price rises. On the other hand, the necessary items demand is little affected by the change in their prices.

For example, even if the price of milk rises a little, people will not stop or reduce consuming milk. On the other hand, if the price of a car rises, the family may decide to postpone the purchase or even abandon it. • Definition of the market-the demand in the monopoly market tends to be inelastic as the consumers have no option but to purchase the item from the same vendor. The demand for commodities in the competitive market is very elastic as the consumers can easily shift from one to another in case of an increase in price.

This is very much like the case of availability of close substitutes. For example, the competitive vegetable market where people buy vegetables primarily on the basis of price. Here, the goods tend to be commodities. However, even the players in the competitive markets have started to form cartels to increase their power like the OPEC where the oil exporting countries have colluded to gain the market power. The example of dominant player in the operating systems market is Microsoft in US.

The demand for Microsoft operating systems and softwares tends to be inelastic because there are very few or no competitors for Microsoft. • Time horizon-The longer a price change holds, the higher the elasticity, as more and more people will stop demanding the goods (i. e. if you go to the supermarket and find that blueberries have doubled in price, you’ll buy it because you need it this time, but next time you won’t, unless the price drops back down again).

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