What is the Price Elasticity of Housing Demand - Essay Example

?introduction Price fluctuations can influence not only the producers but the consumers as well. Changes in prices cause changes in the demand and supply and therefore everyone is influenced because of changes in the price level (Hoover, 2011). Although prices can be controlled by the government but it is a complex process and there are number of factors that need to be considered to understand the changes in the price level. This report is divided into two sections; the first section of the report discusses important terminologies such as Price elasticity of demand, Cross elasticity of demand, Income elasticity of demand and Price elasticity of supply. The other section of the report discusses about the actions that the government can take in order to reduce the fluctuations of commodity prices. Section 1: Explanation of important terms 300 Price elasticity of demand Price elasticity of demand shows the relationship between the changes in the quantity demanded of any specific product with the changes in the price of that specific product. The terminology of price elasticity of demand is generally referred to analyze the sensitivity of the prices of the product (Hanushek, & Quigley, 1980). Price elasticity of demand can be calculated using the following formula: If there is a little change in the prices of the good and this small change can cause a large change in the demand of the product, then such a product is said to be elastic. However if there is a significant change in price level of the product but even this significant change in price level cannot cause a small change in the quantity demand of the product then such a product will be said as price inelastic. Cross elasticity of demand In order to analyze the responsiveness of demand of one product when the price is changed for another product then it is called as the cross elasticity of demand. It is calculated by using the following formula: Income elasticity of demand Income elasticity of demand shows the relationship between the changes in the quantity demanded of the product and the changes in the income level of the consumer. Following formula can be used to calculate the income elasticity of demand: Price elasticity of supply Price elasticity of supply is used to analyze the relationship between the changes in the quantity supply of the product with the change in the price of the product. The following formula is used to calculate the price elasticity of supply Section II: actions that are to be taken to reduce price fluctuations Price is one of the most important factors that influence the purchasing decision of the consumers. It is also the most important factor that influences the production decision of the producers. Therefore changes in price of commodity can influence both the demand and supply of products. Therefore the role of the government is to offer stability in the prices of commodities so that the overall economy can be stable and more stable decisions are taken. There are number of reasons why price level should be stable and one of the most important reasons is that if the prices are more constant and stable then the producers would be able to plan their production accordingly. As producers plan production at a specific level at a constant price, but if the price changes then it can influence supply. For instance, if the price is increased then it will increase the supply of the commodity as shown in the graph below: As the prices have increased, producers want to increase their production so that they can earn more and sell more products at the higher price. However with increase in price, the demand of the products have reduced and thus it is showing that the consumers are not willing to buy the same amount of commodity at the higher prices. Therefore it is showing that the increase in price has increased the supply but it has decreased the demand. Thus a new equilibrium has been formed at Price level P1 and Quantity Q1. Changes in the price level influence the demand and supply of the goods and therefore it is shown that the stability in prices is important. However in order to take actions to reduce the changes in the price level it is important to know what are the factors that influence the prices. The prices can be changed for different reasons for instance, if there is a loss of production or lack of resources that might have not allowed the producers to produce at the desired level and this could influence the total production. Therefore it could cause a decline in the production level. Similarly, poor harvesting can also result in lower production (Milgrom, & Roberts, 1992). Thus with lower supply of goods, consumers would like to purchase the goods even at a higher price. Although not all the consumers would be able to purchase the goods, because of restricted supply as shown in the graph below as the demand of the product will increase Similarly, the demand and supply of goods can be changed because of factors relating to consumers as well. Some of these factors include changes in the income level of the consumers, substitute products, and changes in technology. For instance, changes in the income level can increase the demand of the commodity and if the supply of the commodity is constant then it will result in increasing the price as well as quantity (Baumol, and Blinder, 2012). The following graph shows the increase in demand curve because of changes in the income level of the consumers and thus it has forced an increase in the demand and thus an increase in price level as well as quantity. As the changes in the price level can influence the demand and supply of products. Therefore it is important for the government to intervene and make sure that prices are more stable so that such fluctuations do not occur. Some of the strategies that the government can take to reduce the fluctuations in the prices are offer subsidies to lower the prices of the products if for any reason the supply of the product is low. By offering subsidies the producers would be able to have the remaining amount through subsidies therefore there would not be any changes in the price level. Similarly, the government can intervene and offer a limit on the maximum or minimum price level at which the products can be sold. For instance, to counter the increase in demand of the product, the government can impose a ceiling so that producers do not increase the prices much higher. Another important step that the government can take to reduce the prices of goods is to encourage more industries and more substitute products. If there are more substitutes in the market, then consumers will have more options and they can switch their products easily thus it will encourage price stability (Dornbusch, Fischer, & Startz, 2004). Also if the demand of the product has increased internationally and this has caused not fulfilling of supply of the local consumers then the government can also take actions to restrict the exports of the goods. List of References Baumol, W., and Blinder, A. (2012). Economics: principles and policy. Mason, OH, USA: South Western Cengage Learning. Dornbusch, R., Fischer, S. & Startz, R. (2004). Macroeconomics. New York: McGraw-Hill Companies, Inc. Hanushek, E. A., & Quigley, J. M. (1980). ‘What is the price elasticity of housing demand?’. The Review of Economics and Statistics, vol. 62, no. 3, pp. 449-454. Hoover, K. (2011). Applied Intermediate Macroeconomics. Cambridge: Cambridge University Press. Milgrom, P. & Roberts, J. (1992). Economics, organization and management. London: Prentice-Hall International. Read More