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Define And Explain Price Elasticity of Demand Essay
1344 Words6 Pages
Price elasticity of demand is defined as how demand changes as a result of a change in price. It can be said that if a reduction in price leads to an increase in demand then demand is relatively elastic. Elasticity is usually negative. There is an alternative scenario where demand will increase as price does so too. This happens only in the case of Giffen goods, where elasticity is positive. The formula for price elasticity of demand is:
Percentage Change in Quantity Demanded
Percentage Change in Price One determinant of price elasticity is the number and closeness of substitutes there are available for a good. The closer the goods are, the greater will be the price elasticity of demand of that good. The reason for this being…show more content…
So items like cars have a high income elasticity of demand, whereas items like potatoes have a low income elasticity of demand. For inferior goods, the quantity of goods demanded actually decreases as income goes up. This is true in cases of things like cheap margarine. As people earn more they switch to butter or better quality margarine. Inferior goods have a negative elasticity of demand. The rate at which the desire for the good is satisfied as consumption increases is also a determinant of income elasticity of demand. The more quickly people become satisfied, the less their demand will rise as income increases. The level of income of the consumers is the last determinant factor of income elasticity of demand. Poor people will behave differently, in the event of a rise income, to a rich person. For example, for a given rise in income, a poor person may buy a lot more butter whereas a rich person might only buy a little bit more. Cross Price elasticity of demand is a measure of the responsiveness of demand for one product to a change in the price of a complement or substitute good. The formula for cross elasticity of demand is:
Percentage Change in Demand for Good x
Percentage Change in Price of Good y If good y is a substitute for good x, x’s demand will rise as y’s price rises. Cross elasticity of demand will be positive in this case.