SAMPLE Microeconomics
concept called elasticity, which measures how muchbuyersandsellersrespondtochangesinmarket conditions. A. Price Elasticity of Demand From the previous section, we have discussed how the determinants of demand (price, income, and price of related goods) influence the consumption behavior ofbuyers.Wecandeterminetheeffectof quantitydemandedqualitatively(direction)butnotquantitatively(magnitudeorsizeofthechange).We canmeasurethechangeinconsumerbehaviorinresponsetoachangeinthepriceofagoodorservice. To measure the response or magnitude of price changein demand , we use the concept of elasticity . Price Elasticity of Demand and its Determinants The priceelasticityofdemand measures howmuchthequantitydemandedrespondstoachangein price . We can say that demand is price elastic if the quantity demanded responds substantially toa pricechange.Ontheotherhand,demandisprice inelastic ifthequantitydemandedrespondsminimally to price changes. Thepriceelasticityofdemandforanygooddetermineshowwillingthebuyersaretopurchasemoreor less of the good as its price decreases or increases. Here are some common determinants of price elasticity of demand: ● AvailabilityofCloseSubstitutes. Agoodthathasclosesubstitutesislikelytohaveademand thatispriceelasticbecauseconsumerscaneasilysubstituteonegoodforanother.Forinstance, coffee can be easily substituted for tea or vice-versa. A small increase in the price of coffee (while the priceofteaisconstant)causesthequantityofcoffeesoldtodecreasesincepeople can switch to tea. However, if the good is gasoline, which has no close substitutes, we can expect that the demand is price inelastic or less elastic than the demand for coffee. A small increase in the price of gasoline minimally decreases the quantity demanded for it. ● Necessities versus Luxuries. If consumers require necessities such as drinking water or maintenance medicines, even if their prices rise, the decrease in quantity demanded is only minimal (if not zero). Hence, the price elasticity of demand for these necessities is inelastic. However,ifconsumersareinneedofluxuryitems,suchasaRolexwatchorayacht,evenifthe prices of these luxury items rise, the decrease in quantity demanded is substantial since consumers can postpone their purchasing decision until prices stabilize. Therefore, the price elasticityofdemandfortheseluxuryitemsiselastic.Evaluatingwhetheragoodisanecessityor a luxury depends on the consumer’s preferences and circumstances. ● Definition of the Market. We can define the market as broad or narrow. Narrowly defined markets,suchasthemarketfor‘cookies,’tendtohaveademandthatispriceelasticbecauseit iseasiertoreplacecookieswithanothertypeofbakedgoods.Broadlydefinedmarkets,suchas the market for “food,” have a demand that is price inelastic because no other category can replace food.
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