The Analysis of the Cross Price Elasticity - Essay Example

Macro and Microeconomics: Price Elasti Discuss cross price elasti as it pertains to substitute goods and complementary goods Cross-price elasticity as it pertains to the demand generally measures good demand responsiveness to price change of another good. In most cases, cross-price elasticity of demand tends to measure the rate of quantity response that is demanded on a particular good because of price change of a different good (Tobin, 1987). In this case, substitute goods generally refer to a pair of goods in which the consumers consider alternative. On the other hand, complementary goods are those that are used together; one item is usable only when the other item is available. In this case, if goods A and B are complementary, they have to be purchased together for a consumer to reap their utility. Complementary goods have a negative cross elasticity of demand; this implies that the demand of good A increases when the price of good B is decreased, where goods A and B are complementary goods. Conversely, the demand for A is decreased when the price of B is increased. This basically means that when higher quantity of A is demanded due to price decline, the demand of B will equally increase since A cannot be used without B. substitute goods exhibit positive cross-price elasticity of demand. Suppose X and Y are substitute goods. When price of Y goes up, consumers will go for X at a cheaper price but with similar utility as Y Discuss income elasticity as it pertains to inferior goods and to normal goods (sometimes also called superior goods) The income elasticity of demand measures the degree of change in demand of a commodity in response to changes in consumer’s income level. Inferior goods are those goods that a person may consider using when they do not have enough money, for example a cheap car. With little income, the demand for cheap cars will go up. Once the income increases, people tend to prefer more expensive cars and hence the demand of cheap cars goes down. Normal goods have a normal demand curve. In this case, the demand of a normal god will increase as the level of income increases. Conversely, the demand of a normal commodity will decrease with the level of income (Tobin, 1987). Discuss why demand tends to be relatively elastic in a situation where “Availability of Substitutes” exists. Various aspects including the availability of substitute products or goods, necessity degree and the greater the elasticity of good demand mostly influence the price elasticity of goods demands. Generally, demand tends to be elastic when there is availability of substitute goods in the market (Landsburg, 2011). In this case, the greater the substitute products in the market would result to demand elasticity. The best example is the Coca-Cola and Pepsi situation where the market is always flooded with availability of substitute products thus making the demand of the two products elastic. Proportion of income Devoted to a Good concept During budget, individuals allocated income to the purchasing of various goods. Some good are required in large quantities while others are quite expensive. On the other hand, some goods are cheap and required in small quantities. In this case, varied proportion of the income will be allocated on each product. The portion of income set aside for a particular item can be taken to be the proportion of income devoted to that particular item. Consider two types of goods commonly used in American households; sugar and clothing. Suppose a household X allocates five percent of their income on sugar while fifteen percent goes on clothes every month. In this case, five percent and fifteen percent are the proportion of income devoted to sugar and clothes respectively. How the same percentage change in the price of both goods affects the percentage change in the quantity demanded for each of the two goods In case the prices of the two commodities change with similar, the smaller the portion of income devoted to a commodity, the more its demand will be inelastic. Therefore, if the prices of sugar and the clothes increase with similar margin, the demand for sugar will remain the same but that of clothes will decrease. Conversely, if the prices of the two commodities decrease, same amount of sugar will be demanded but that of clothes will go up Contrast how a person would initially respond to a relatively large increase in the price of a product in the short run as opposed to how that same person might react to that same price increase over a longer time horizon (i.e., the long run), using the “Consumers Time Horizon” concept. Short-period: during the short period, it is not possible for a consumer to conveniently adjust their demand for a commodity in order to cope with the price change in the market. Even though the commodity is a necessity or for comfort purposes, it may be undesirable for the consumer to make an abrupt change in his demand for the product. Therefore, in the short-run the change in the quantity demanded will be restricted by human nature or because the customer is habituated to it. In this case, the demand will be inelastic. Long- period: during the long-run period, it is conveniently achievable for the buyer to modify the demand for a commodity due to change in its cost in the market. Furthermore, even if the commodity is a necessity, the customer will try to change to the commodity that gives him maximum satisfaction. In this case, the consumer can even adopt to living without some habitual products and therefore, the elasticity of demand is extra than that in the short-run . How a consumer would "react" to a large price increase in both the short run and the long run In the short run, the customer will continue buying the commodities but in a declining trend. The consumer will tend to cut on the consumption; in this case, we assume that they allocated definite amount of income on the commodity. The income would be rationed so as to cover the period up to the next payment. In the long run, the consumer will have several options to consider. Firstly, the consumer will consider establishing a close substitute of the commodity. Secondly, they may consider adopting to low levels of consumption of the more expensive goods. All these and many other choices that the consumer can have will lead to a decline in the quantity demanded. The notions of large price increase as well as demand and supply remains fundamental in economics. The concept in this case is that consumers may not be willing to purchase larger quantity of products in case the prices rise in a short run. Large increase in product price in a short run would most likely not go well with the product consumers as opposed to increase in product price over a long period. In most cases, consumers prefer having enough consideration time and not impromptu spending. Less consumer time horizon will most likely lead to poor sales or lower consumer purchases (Landsburg, 2011). The price ranges where the demand curve is elastic, inelastic, and unit elastic t Elastic demand obtain prices ranges for the three scenarios, it is important to obtain a schedule for both demand against the prices. price 90 80 70 60 50 40 30 20 10 0 Quantity demanded 1 1 2 3 4 5 6 7 8 9 Since elasticity (Ed) = unit change in quantity demanded, and Unit Change in price Value Type of demand Inelastic Unit elastic, Elastic Price range 50 - 80: Ed = 1 – 1 = 0 and therefore the demand is inelastic. 1 Price range 40 to 50, (Ed) = unit change in quantity demanded, and = 1 and hence the demand is Unit elastic Unit Change in price During inelastic demand, a change in price does not affect the quantity that consumers are will and able to buy. In this case, the revenue realized from the sale increases rapidly since same number of items is sold at a higher price. 50 - 80 In elastic demand a small change of price results in to a bigger change in the quantity demanded. In this case, the quantity demanded will reduce, but not by a very huge margin, and hence total revenue will drastically reduce. Unit elastic: price range 10 - 40 In this case, a unit change in price results in proportionate change in quantity demanded. Therefore, the total revenue realized during unit elastic period remains relatively constant but shows a declining trend. References Landsburg, S. E. (2011). Price theory and applications. Australia: South-Western/Cengage Learning. Tobin, J. (1987). Essays in economics: Volume 2. Cambridge, Mass: MIT Press. Read More