Very Short Question Answer
1. Define elasticity of demand.
Elasticity of demand is defined as the responsiveness of change in demand to the change in factors determining demand.
2. What are the different types of elasticity of demand?
There are three types of elasticity of demand, which are as follows:
i. Price elasticity of demand
ii. Income elasticity of demand
iii. Cross elasticity of demand
3. Point out any four importance of price elasticity of demand. Or, What are the uses of price elasticity of demand in business decision making?
The four importance of price elasticity of demand are as follows:
i. Price determination
ii. Wage determination
iii. International trade
iv. Importance to finance minister to prepare budget
4. Make a list of any four importance of income elasticity of demand.
The four importance of income elasticity are as follows:
i. To know about stages of trade cycle.
ii. Demand forecasting
iii. Classification of goods in normal and inferior
iv. Useful to make marketing strategies
5. List out any four importance of cross elasticity of demand.
The four importance of cross elasticity of demand are as follows:
i. Classification of goods
ii. Classification of markets
iii. Pricing policy
iv. Classification of industries
6. Write down any four determinants of elasticity of demand.
The four determinants of elasticity of demand are as follows:
i. Nature of the commodity
ii. Existence of substitute goods
iii. Income of the consumer
iv. Price level
Short Question Answer
What is meant by price elasticity of demand? Explain its uses or importance in business decision-making?
Price elasticity of demand is defined as the responsiveness of change in quantity demanded to the change in price of commodity. It is measured by the ratio of percentage change in quantity demanded and percentage change in price.
Ep= Percentage change in quantity demanded /Percentage change in price
= (ΔQ/ Q × 100) / ( ΔΡ/ Ρ x 100)
Ep = Price elasticity of demand
P = Initial price
Q = Initial quantity demanded
ΔΡ Change in price
ΔQ = Change in quantity demanded
Uses or Importance of Price Elasticity of Demand (EP):
Price elasticity of demand has great practical importance in the formulation of economic policies and understanding economic problem The importance of price elasticity of demand are as follows:
i. Monopoly price determination: A monopolist while fixing the price of the product has to see whether the demand for the product is elastic or inelastic If the demand for his product is elastic, he can get more profit by fixing a low price. If the demand for his product is inelastic, he can get more profit by fixing high price. Thus, a producer under monopoly competition has to study the degree of elasticity of demand in pricing his product.
ii. Price determination under discriminating monopoly: Under discriminating monopoly, different prices for the same product are charged in different markets Low price is charged for the products in the market having elastic demand and high price is charged in the market having inelastic demand
iii. Price determination of public utilities: The concept of price elasticity of demand is very useful to determine the price of public utilities such as postal services, drinking water, electricity, etc. The price of these services should be determined on the basis of elasticity of demand if the demand for services is inelastic, a high price is charged. If the demand for service is elastic, a low price is charged.
iv. Price determination of joint products: The price elasticity of demand is useful in the pricing of joint products like sheep & wool wheat & straw cotton & cotton seeds, etc. In such cases, the cost of production of each product cannot be calculated separately. Price of each product should be determined on the basis of elasticity of demand. Higher price is charged for the product with inelastic demand and the lower price is charged for the product with elastic demand.
v. Wage determination: The concept of price elasticity of demand is important in the determination of wages of a particular type of labor. fif the demand for service of labor is inelastic, they can force the employer to increase the wage organizing strike On the other hand, if demand for service of labor is elastic, strikes & other trade union tactics would not work.
vi. International trade: Price elasticity of demand has great practical importance for determining terms of trade. The terms of trade depends upon relative elasticity of goods exported & imported between the countries A country gains from international trade if it exports goods having inelastic demand in importing countries and imports goods for which demand is elastic in domestic market
vii. Importance to finance minister: The concept of price elasticity of demand is great importance to the finance minister. The finance minister has to find out how he can collect more revenue to the state Imposition of higher tax rate on goods with inelastic demand or necessary goods brings more revenue to the government as increase in price due to tax does not affect demand much. However, heavy tax on poor people is not socially justifiable. Hence, low rate of tax should be imposed on necessaries and high rate of tax should be imposed on luxuries goods.
What are its uses or importance of cross elasticity of demand?
The concept cross elasticity is very useful to producer & businessman to make pricing decision. The major importance of cross elasticity of demand is given below:
i. Classification of goods: Goods are classified into substitute a complementary. If cross elasticity of demand between any two goods is positive, the goods may be considered as substitutes for each other. If the cross elasticity is greater, the goods are closer substitute. If it is infinite, they are perfect substitute. If the cross elasticity of demand for any two related goods is negative, the two goods may be considered as complementary for each other. If the negative cross elasticity of demand is high, the degree of complementarily is also high.
ii. Classification of market: Market structure has been classified by Prof. Bain on the basis of cross elasticity of demand. f the cross elasticity of demand is infinite, the market is perfectly competitive. If the cross elasticity is zero or almost zero, the market structure is monopoly. If the cross elasticity is high there is imperfect market.
iii. Pricing policy: Large firms produce different related goods. For example, Nepal Liver Limited produces various brands of tooth paste & tooth brush. They are complementary goods. Similarly, Nepal Dairy Limited produces ice cream of different flavor. They are substitutes. Cross elasticity of demand helps firms to decide whether to increase price of related products or not.
iv. Determination of boundaries between industries: Concept of cross elasticity of demand is useful in order to decide to which product should include in which industry. If related goods having negative cross elasticity (complementary goods), they belong to different industries. If the related goods having positive cross elasticity (substitute goods), they belong to one industry.
Explain the determinants of elasticity of demand.
The elasticity of demand for any commodity is determined by a number of factors which are explained below:
i. Nature of the commodity: The elasticity of demand for any commodity depends upon the nature of the commodity, i.e., whether it is a necessity, comfort or luxury The demand for necessities of life is generally less elastic. The demand for comfortable goods like milk, fan, freeze, etc. is neither very elastic nor very inelastic demand because with the rise or fall in their prices, the demand for them decreases or increases moderately On the other hand, the demand for luxuries goods is more elastic, because, with a small change in their prices, there is a large change in their demand.
ii. Substitute: Commodities having substitutes have more elastic demand because with the change in the price of one commodity, the demand for its substitute is immediately affected. For example, if the price of coffee rises, assuming that price of tea remains constant, the demand for tea increases and vice-versa.
iii. Goods having several uses: If a commodity has several uses, it has an elastic demand. For example, electricity has multiple uses. It is used for lighting, room heating, cooking, etc. If the tariffs of electricity increase, its uses will be restricted to important uses. On the other hand, if its tariffs decrease, it will be used for many uses like cooking, room heating etc.
iv. Joint demand: There are certain commodities, which are jointly demanded such as car & petrol, pen & ink, bread and butter etc. The elasticity of demand of the second commodity depends upon the elasticity of demand of the major commodity. For example, if the demand for car is less elastic, the demand for petrol will also be less elastic.
v. Income of the consumer: The elasticity of demand also depends on income of the consumers. If the income of consumers is high, the elasticity of demand is less elastic. It is because change in the price will not affect the quantity demanded by a greater proportion. But in low income groups, the elasticity of demand is elastic. It is because a rise or fall in the price of commodities will decrease or increase the demand. But this does not apply in the case of necessities.
vi. Postpone of the consumption: Those commodities whose consumption can be postponed will be elastic. For example, demand for constructing a house can be postponed. As a result, demand for bricks, cement, sand, etc. will be elastic. On the other hand, goods whose demand cannot be postponed, their demand will be inelastic.
vii. Habits: People who are habituated to the consumption of a particular commodity, like, coffee, tea; cigarette of a particular brand, the demand for it will be inelastic.
viii. Price level: The price level also influences the elasticity of demand. When the price level is too high or too low, the demand will be comparatively inelastic. But in case of middle range of prices, demand is elastic.
ix. Time factor: Time factor plays an important role in influencing the elasticity of demand. The elasticity of demand is greater in the long-run than in the short run because in long-run the consumer has enough time to make adjustment in his scheme of consumption.
Define the elasticity of supply. Explain factors influencing or determining elasticity of supply.
The elasticity of supply is defined as the responsiveness of quantity supplied of a commodity to the change in its price. The price of elasticity of supply is defined as the ratio between percentage change in quantity supplied and percentage change in price of a commodity. It can be expressed as:
Es =Percentage change in quantity supplied/Percentage change in price
Where Es = Coefficient of elasticity of supply
The following factors are the main factors, which influence the supply elasticity:
i. Nature of the commodity: The supply elasticity of durable goods is very high because durable goods can be stored for a long time. The producers are not bound to sell them in the market soon. The supply elasticity of perishable goods is low since perishable goods cannot be stored for a long time.
ii. Cost of production: If production is carried out under the condition of constant return to scale, then supply can be expanded at the given price. In other words, this is a case of relatively elastic supply. If production is carried out under the condition of diminishing returns to scale, which implies that marginal cost rises as the production expands, then we have a case of inelastic supply.
iii. Time element: In the long-run the supply elasticity will be relatively elastic because the production can be increased in the long-run. In the short-run, the supply elasticity will be relatively inelastic because the productive capacity is limited.
iv. Producers expectation: If producers expect a rise in the price of a commodity in the future, they will cut down the present supply. As a result, the supply will be inelastic. If they expect the price to fall, in the future they will increase the present supply. Consequently, the supply will become elastic.
v. Technical condition of production: Supply elasticity depends upon technical condition used in the industry. In all those industries, where large plants are set up and production is carried out on a large scale, elasticity of supply is very low because for setting up huge plants, large capital & technical expertise is required which is not easily available. Thus, the supply of product in these industries cannot be increased easily. If the technology is simple and capital equipment are less costly, the supply of the product will be relatively elastic.