Price Elasticity of Demand - Essay Sample

Price elasticity of demand (PED) refers to how elastic or responsive the demand for a good or service is to changes in their respective prices also known as ceteris paribus. In more precise terms, it indicates the degree to which a percentage change in the quantity demanded response to a one percentage point change in the price of either a good or a service. The price elasticity of demand is usually determined by the ability of consumers to postpone the consumption of a particular good or service due to the changes in price and instead opt for a cheaper substitute. With this in mind, the PED can thus be determined and affected by factors such as substitute goods availability, loyalty to a particular brand, the percentage of consumers' income represented by a product's price, and the necessity of a given product (Anderson et al 1997).

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The more available a close substitute to a given product is, the more the price elasticity of demand since consumers can easily and swiftly switch between substitute products whenever a slight price change is introduced to the product. For a good or service that doesn't have a close substitute, the price elasticity of demand remains rather inelastic as consumers do not enjoy the choice of switching between closely competing products. With the loyalty factor, the demand elasticity is likely to be more inelastic as people tend to stick to those products that they are attached to irrespective of any price changes.

As far as the percentage of consumers' income is concerned, people tend to buy less of a product if the product represents a significant percentage of their income implying elastic demand elasticity. The price elasticity of demand becomes inelastic when the percentage of the income represented by a product's price is negligible relative to the total income of the consumer. The necessity of a particular product also plays a significant role in as far as the price elasticity of demand for that product is concerned. A good or service with which a consumer cannot do without has an inelastic demand as the quantity demanded of the product/service does not respond to any changes in price. For instance, however much the prices of insulin hike, diabetic patients still have to purchase the insulin because it's a necessity important for their survival.

A product's demand is said to be elastic if any changes introduced at the price of the product results in a very large and significant effect in quantity demanded of the product. A price elasticity of demand is always greater than one in the case of elastic demand. On the other hand, an inelastic demand for a good happens when the demand for the good doesn't change significantly with a change in the unit price of the good. In inelastic demand, the PED is always less than one (Anderson et al 1997).

The price of a laptop increases by 20%, and there is a 40% decrease in the quantities of goods demanded.

Price Elasticity of Demand= Percentage change in Quantity demanded/ Percentage change in price

PED= -40/20

PED= |-2|=2

The price of a pack of cigarettes increases by 10%, and there is a 5% drop in the quantity demanded.

Price Elasticity of Demand= Percentage change in Quantity demanded/ Percentage change in price

PED= -5/10

PED= |-1/2|=1/2

From the above computations, the laptops have got a more elastic demand since the absolute PED value is greater than one while the cigarettes have got a less elastic demand since the associated absolute PED value is less than one.

For a business operating a toll bridge/s, the concept of elasticity comes in handy when determining when to increase the toll fees and when not to increase the toll to ensure that the demand either remains the same or increases. The bridge toll operators should consider increasing the toll when the traffic of people who use the bridge increases and reduce the price significantly when the traffic reduces.

For a beachfront properties business, consideration for price hikes should be made during holiday seasons when the number of merry makers is on a high. These are normally the peak holiday seasons such as Christmas where demand for the services offered id high. A reduction should, however, be effected during off-peak periods when the demand is low to entice more customers.

The elasticity concept helps Gourmet's coffee define a perfect time when a change in their coffee prices won't affect the demand for the coffee. This would then have to be during cold seasons as more people would prefer taking coffee even with an increased per unit coffee price.

A gasoline dealership would benefit from elasticity by understanding the price and demand dynamics of the market. With a market where gasoline substitutes are non-existent, a business dealing in gasoline could consider increasing their profit margins by raising the prices a little bit without any major effect on the demand for gasoline. This would particularly be in those areas where people use cars more often, and there is no alternative form of transport.

Elasticity concepts help businesses dealing in the sale of cell phones identify the type of cell phone brands that resonate with the consumers due to their demand. They are then able to identify the brands acceptable in the market whose demand won't change significantly with a change in the prices of the phones.

The demand for flowers is usually high during periods characterized by events and occasions that require the use of the flowers. The best period, therefore, to effect price increases of flowers would be periods occasioned by the necessity of the flowers such as in February during valentines and in such periods as the festive season which are usually at the end of the year. During these times, the demand for the flowers is usually high as the flowers become a necessity meaning that price increases won't result in any significant changes in the quantities demanded. Though this might be the case, the flower business is usually elastic with demand for the flowers always exhibiting a high level of responsiveness to changes in price when the period is not right.

References

Anderson, P. L., McLellan, R. D., Overton, J. P., & Wolfram, G. L. (1997). Price elasticity of demand. McKinac Center for Public Policy. Accessed October, 13, 2010.