Demand I Question 5 A Explain the concept of price elasticit

Demand (I (Question 5): A. Explain the concept of price elasticity of demand. What does it capture and why is it important? As part of your answer you may want to discuss how the elasticity of demand may affect other useful metrics e.g. revenue. B. What happens to the elasticity as you move from the left to the right of the demand curve i.e. is it increasing or decreasing. Show this mathematically and explain why intuitively. C. Suppose that the equation of a demand curve is Q = 30 -2P. This represents the demand for headphones what is the price elasticity of demand when 10 units are consumed? D. Suppose that only 4 units are consumed. Calculate the price elasticity at this point and identify a factor which could cause the number of headphones consumed to decrease to 4. E. Now suppose that there is a decrease in the demand for headphones. Suggest a factor which could cause a decrease in demand.

Solution

A.

The elasticity of Demand measures the extent to which quantity demanded of a commodity increase or decrease in response to increase or decrease in any of its quantitative determinants. The elasticity of demand measures the responsiveness of the quantity demanded of a good, to change in its price, price of other goods and change in consumer\'s income.

Some goods are elastic and others are inelastic because of various factors like: Nature of commodity, availability of substitutes, different uses of commodity, postponement of the use, income of the consumer, habit of consumer, proportion of income spent on a commodity, price level and time period.

There exists a relationship between total revenue and elasticity of demand. When demand is inelastic, then increase in price causes increase in total revenue and vice-versa. On the other hand, when demand is elastic, then increase in price causes decrease in TR and vice-versa.

B. Elasticity of demand decreases as we move from left to right on the demand curve. On the vertical axis, Ed = Infinity while on x-axis, Ed = 0.

C. Ed = P/Q x dQ/dP

When Q = 10 then 10 = 30 - 2P

2P = 20

P = 10

and dQ/dP = - 2

Ed = 10/10 x - 2 = - 2

D. Q = 4 implies 4 = 30 - 2P

2P = 26

P = 13

dQ/dP = - 2

Ed = 13/4 x - 2 = - 6.5

Causes of decrease in consumption of headphones:

a) Decrease in the income of person.

b) Decrease in the price of substitute good of headphones.

c) Unfavorable taste and preference of the consumer.