The concepts of price elasticity of demand of a commodity is of great essentiality in economics as it shows how much the demand of a commodity will change as a result of price deviations. In other words it shows how the demand of the commodity responds to a price change. There are three common methods that are used in the computation of price elasticity namely; Total revenue method, Geometrical method and the Arc method. Computation of price elasticity is done based on the formula below;
- Price elasticity of demand = % change in quantity demanded / % change in price of the commodity.
In deciding the type or nature of demand the results of the computation are checked and used to make the decision. In the case the results of the computation is a figure greater than one, then the demand is price elastic meaning that it responds largely to changes in price (Schenk, 2009, p.1). This can be further explicated by concluding that the percentage change in demand of an elastic situation is higher than the percentage change of price of the same commodity thus referred to as price elastic. In a situation where the resulting figure computed equals to one, then the demand is therefore defined as unit elastic or rather unitary elasticity whereby a price change will have no effect on the demand.
This situation mostly happens in monopolistic markets whereby the commodity has no substitutes. Lastly, is the situation whereby the figure computed is less than one to mean that a change in price has a lesser effect on the demand thus inelastic demand (Schenk, 2009, p.1). In this case, the demand of the commodity is less responsive to the price changes. A situation of relatively elastic occurs where the computed figure of price elasticity of demand is greater than one but less than infinity. On the other hand, relatively inelastic situation will occur in the instance that the computed figure for price elasticity is greater than zero but less than one.
This is explained in the graph below;
Given definitions of price elasticity of demand and what is inelastic demand, determine the relative price inelasticity of demand of the following goods as which is most, moderate and least inelastic and why:
- Swiss cheese.
- Dairy products.
Determination of the Relative Price inelasticity of the three commodities
Different goods have different price elasticity with the lowest elasticity being witnessed in normal goods where a price change has very little effect on the quantity demanded of the commodity.
This is one of the many types of cheese manufactured for sale. This in economics terms would mean that this commodity has many substitutes such that incase of any factor that would affect its production and demand consumers would still have other options of the commodity. For instance in the case that the price of Swiss cheese goes up, customers would therefore switch to using other cheese types such as cheddar.
As a matter of fact all types of cheese are manufactured from the same ingredients and process with slight deviations in the maturing process which leads to the hard or soft cheese, salty or non-salty, flavored or non-flavored among others. This therefore means that the relative price inelasticity of Swiss cheese is the least since a change in price of the will lead to a big change in the quantity demanded since the commodity has several substitutes which belong to the same group.
This is a broader group of the different types of cheese but at the same time it is also the sub-set of dairy products. Cheese is a dairy product that is manufactured from the fermentation of milk. This in economic terms means that cheese will have fewer substitutes as compared to the Swiss cheese given the fact that not all dairy products are fermented. Thus there will be a group of people who will prefer cheese to other dairy products as a result of the difference in manufacturing process and uses. For instance, cheese cannot be grouped together with ice-cream or milk-shake despite the fact that they are all dairy products. Thus cheese will be moderately responsive to the price changes hence being the moderately price inelastic commodity.
This is a larger group of the above commodities and very specific of the three. This is because dairy products are only produced from milk and no other raw material. Therefore, there are fewer substitutes for dairy products hence making the demand least respond to the price changes. In the instance a consumer substitutes dairy products such as sodas or juices, the contents will be different as well as the nutritional value. As a matter of fact dairy products have different satisfaction levels from their close substitutes. This therefore means that the dairy products are the most inelastic of the three commodities given.
Also what is the likely cross price elasticity of the least elastic good from above going to be like and why for:
Cross-price elasticity is another important concept in economics which determines how much a commodity responds to changes in prices of other related commodities (Moffat, 2011, p.1). It is used to determine if any two products are in competition with each other, or if they are substitutes, compliments or independent. It is computed as follows;
Cross-Price elasticity of demand = % change in quantity demanded of commodity A / % change in price of the commodity of commodity B (Moffat, 2011, p.1).
From the above three commodities, dairy products are the least elastic as discussed above. Bread is a commodity that is used as an accompaniment with many dairy products such as tea, fresh milk, yoghurt just to mention but a few. Therefore the cross price elasticity of dairy products and bread will be negative as the two commodities are compliments.This is because price changes in one of the two commodities will have very little effect on the demand of the other commodity. For example, in the case the prices of bread goes up, consumers will still buy the commodity since it is an accompaniment for their dairy products especially for breakfast.
On the other hand, Juice is a competitor or rather a substitute for dairy products hence their cross-price elasticity will be positive since a change in price of either commodity will have a positive impact on the demand of the other commodity. For instance, if the price of dairy products goes up due to factors affecting supply such as climatic changes, people may opt to taking juices for breakfast instead of having the cup of milk they are used to. The vice versa is also true.
Moffat, M. (2011). Cross-Price Elasticity of Demand. Web.
Schenk, R. (2009). Price Elasticity. Web.