Assignment

Faculty Of Business, Finance & Hospitality

Submitted To:
Mazlina Muhamad.
Lecturer in Microeconomics.
Mahsa University.
Submitted By:
Ahmad Aamir.
BBAF17041091.
Year 1, Semester 1 (Jan 2017)
Mahsa University.
 Contents

1.0 Define the price elasticity of demand and the income elasticity of demand. .................................. 3
1.1 Types of Demand Elasticity ................................................................................................................ 4
1.2 Examples ............................................................................................................................................. 4

2.0 List and explain the four determinants of the price elasticity of demand. ........................................ 5
2.1 Four determinants of the price elasticity of demand ........................................................................... 5

3.0 If the elasticity is greater than 1, is demand elastic or elastic? If the elasticity equals 0, is demand
perfectly elastic or perfectly inelastic?.......................................................................................................... 6

4.0 Give an example of a price ceilling and an example of price floor. ................................................. 7

5.0 Explain how buyers willingness to pay, consumer surplus and the demand curve related? ........... 8

6.0 Explain how sellers seller’s costs, producer surplus and supply curve are related? ......................... 9

7.0 Conclusion ...................................................................................................................................... 10

8.0 References ............................................................................................................................................ 10

1.0 Define the price elasticity of demand and the income elasticity of
demand.

In economics, income elasticity of demand measures the responsiveness of the quantity

demanded for a good or service to a change in the income of the people demanding the good,
ceteris paribus. It is calculated as the ratio of the percentage change in quantity demanded to the
percentage change in income.

The formula for calculating income elasticity of demand is the percent change in quantity
demanded divided by the percent change in income. With income elasticity of demand, you can
tell if a particular good represents a necessity or a luxury.

Price elasticity of demand is a measure of the relationship between a change in the quantity
demanded of a particular good and a change in its price. Price elasticity of demand is a term in
economics often used when discussing price sensitivity.

The price elasticity of demand is the percentage change in the quantity demanded of a good or
service divided by the percentage change in the price. The price elasticity of supply is the
percentage change in quantity supplied divided by the percentage change in price.

Demand elasticity refers to how sensitive the demand for a good is to changes in other economic
variables, such as the prices and consumer income. Demand elasticity is calculated by taking the
percent change in quantity of a good demanded and dividing it by a percent change in another
economic variable.

Demand elasticity refers to how sensitive the demand for a good is to changes in other economic
variables, such as the prices and consumer income. Demand elasticity is calculated by taking the
percent change in quantity of a good demanded and dividing it by a percent change in another
economic variable. A higher demand elasticity for a particular economic variable means that
consumers are more responsive to changes in this variable, such as price or income.

Demand elasticity measures a change in demand for a good when another economic factor
changes. Demand elasticity helps firms model the potential change in demand due to changes in
price of the good, the effect of changes in prices of other goods and many other important market
factors. A grasp of demand elasticity guides firms toward more optimal competitive behavior and
allows them to make more precise forecasts of their production needs. If the demand for a
particular good is more elastic in response to changes in other factors, companies must be more
cautions with raising prices for their goods.
1.1 Types of Demand Elasticity

One common type of demand elasticity is the price elasticity of demand, which is calculated by
dividing the percent change in quantity demanded of a good by the percent change in its price.
Firms collect data on price changes and how consumers respond to such changes and later
calibrate their prices accordingly to maximize their profits. Another type of demand elasticity is
cross-elasticity of demand, which is calculated by taking the percent change in quantity
demanded for a good and dividing it by percent change of the price for another good. This type
of elasticity indicates how demand for a good reacts to price changes of other goods.

Demand elasticity is typically measured in absolute terms, meaning its sign is ignored. If demand
elasticity is greater than 1, it is called elastic, meaning it reacts proportionately higher to changes
in other economic factors. Inelastic demand means that the demand elasticity is less than 1, and
the demand reacts proportionately lower to changes in another variable. When a change in
demand is proportionately the same as that for another variable, the demand elasticity is called
unit elastic.

1.2 Examples

Suppose that a company calculated that the demand for soda product increases from 100 to 110
bottles as a result of the price decrease from $2 to $1.50 per bottle. The price elasticity of
demand is calculated by taking a 10% increase in demand (10 bottles change divided by initial
demand of 100 bottles) and dividing it by a 25% price decrease, producing a value of 0.4. This
indicates that lowering soda prices will result in a relatively small uptick in demand, because the
price elasticity of demand for soda is inelastic. Also, an increase in total revenue will be smaller
in this case compared to more elastic demand for soda.
2.0 List and explain the four determinants of the price elasticity of
demand.

Price elasticity of demand is a measure of the relationship between a change in the quantity
demanded of a particular good and a change in its price. Price elasticity of demand is a term in
economics often used when discussing price sensitivity.

Demand elasticity refers to how sensitive the demand for a good is to changes in other economic
variables, such as the prices and consumer income. Demand elasticity is calculated by taking the
percent change in quantity of a good demanded and dividing it by a percent change in another
economic variable. A higher demand elasticity for a particular economic variable means that
consumers are more responsive to changes in this variable, such as price or income.

2.1 Four determinants of the price elasticity of demand

Substitutability
The larger number of substitute goods the greater the price elasticity of demand. (Candy bars)
Demand will depend on narrowly defined the products are. (tooth pulling vs. a candy bar)

Proportion of Income
The higher the price of a good relative to someone's income the greater the price elasticity of
demand. (10% increase in a pencil vs 10% increase in a car)

Luxuries vs Necessities
The more something is considered a 'luxury' the more the price elasticity of demand. Electricity
is a necessity so not as affected. However, a vacation is a luxury and could be done without and
you won't suffer without a vacation.

Time
Products are more elastic the longer the time period under consideration. Consumers need time
to adjust to price increases. For example, if beef increases by 10%, consumers may eventually
switch to chicken or fish but not necessarily right away. (Fazar, 2016)
3.0 If the elasticity is greater than 1, is demand elastic or elastic? If
the elasticity equals 0, is demand perfectly elastic or perfectly
inelastic?

If the price elasticity of demand is equal to 0, demand is perfectly inelastic. Values between zero
and one indicate that demand is inelastic, this occurs when the percent change in demand is less
than the percent change in price.

An elasticity that is greater than one is elastic. When the elasticity is greater than one, the
persantage changes in quantity demanded exceeds the persentage change in price. When it equals
0, it is perfectly inelastic. There is no change in quantity demanded when there is a change in
price. (Fazar, 2016)
4.0 Give an example of a price ceilling and an example of price
floor.
Price ceilings only become a problem when they are set below the market equilibrium price.
When the ceiling is set below the market price, there will be excess demand or a supply shortage.
Producers won't produce as much at the lower price, while consumers will demand more because
the goods are cheaper.
5.0 Explain how buyers willingness to pay, consumer surplus
and the demand curve related?

1. Figure 1 (on the next page) shows the demand curve for turkey. The price of turkey is
P
1
and the consumer surplus that results from that price is denoted CS. Consumer surplus is the
amount a buyer is willing to pay for a good minus the amount the buyer actually pays for it. It
measures the benefit to buyers of participating in a market.
Figure 1 Figure 2
2. Figure 2 shows the supply curve for turkey. The price of turkey is
P
1
and the producer surplus that results from that price is denoted PS. Producer surplus is the amount
sellers are paid for a good minus the sellers’ cost of providing it (measured by the supply curve).
It measures the benefit to sellers of participating in.
6.0 Explain how sellers seller’s costs, producer surplus and supply
curve are related?

Welfare Economics
the study of how the allocation of resources affects economic well-being.

Willingness To Pay
The Max amount that a buyer will pay for a good

Consumer Surplus
The amount a buyer is willing pay for a good minus the amount the buyer actually pays for it.

Cost
the value of everything a seller must give up to produce a good.

Producer Surplus
The amount a seller is paid for a good minus the seller's cost of providing it.

Efficiency
The proper of resource allocation of maximizing the total surplus received by all members of
society.

Equality
The property of distributing economic prosperity uniformly among the members of society.
Explain how buyer's willingness to pay, consumer surplus, and the demand curve are related.
Consumer surplus equals buyers' willingness to pay for a good minus the amount they actually
pay, and it measures the benefit buyers get from participating in a market. Consumer surplus can
be computed by finding the area below the demand curve and above the price.
Explain how sellers' costs, producer surplus, and the supply curve are related
Producer surplus equals the amount sellers receive for their goods minus their costs of
production, and it measures the benefit sellers get from participating in a market. Producer
surplus can be computed by finding the area below the price and above the supply curve.
What is efficiency? It is the only goal of economic policymakers?
An allocation of resources that maximizes the sum of consumer and producer surplus is said to
be efficient. Policymakers are often concerned with the efficiency, as well as the equality, of
economic outcomes.

Name two types of market failure. Explain why each may cause market outcomes to be
inefficient.

If markets do not allocate resources efficiently in the presence of market failures much as market
power or externalities.
7.0 Conclusion

In economics, income elasticity of demand measures the responsiveness of the quantity

demanded for a good or service to a change in the income of the people demanding the good,
ceteris paribus. It is calculated as the ratio of the percentage change in quantity demanded to the
percentage change in income.

8.0 References

Fazar, O. (2016). Principles Of Economics. Oxford.