ask 2: Elasticity 1. Consider the following two products: 3D television and pres
ID: 1139612 • Letter: A
Question
ask 2: Elasticity 1. Consider the following two products: 3D television and prescription. Which product would have a higher price elasticity of demand in absolute value? Explain your answer including identifying the determinant of elasticity. (1 mark) – Maximum number of words 60 2. Consider the following two products: Coffee sold in a café or electricity (assume limited excess capacity). Which product would have a higher price elasticity of supply in absolute value? Explain your answer including identifying the determinant of elasticity. Coffee sold in a café or electricity (assume limited excess capacity). (1 mark) – Maximum number of words 60
Explanation / Answer
1. Price elasticity of demand is the responsiveness of demand to a change in price. Usually the demand for a product changes when it price change. The price elasticity shows how much or at what extent the demand changes with change in price.
The price elasticity depends upon various factors like:
1. Nature of the commodity.
The necessary commodities like salt kerosene oil, vegetables have inelastic demand.
2. Availability of substitutes.
The demand for goods which have close substitute will have an elastic demand (tea and coffee).
3. Multiple uses
The goods with multiple uses have an elastic demand (electricity) .
4. Postponement of uses.
The demand will be elastic for goods, the consumption of which can be postponed.
5. Income level of the buyer.
The high income consumer does not care about the price. Thus their demand is less elastic. The demand for low income groups is elastic as they are more conscious of price changes.
6. Habit of consumers.
The goods on which the consumers are habitually addicted will have inelastic demand. Example cigarettes and liquor.
7. Proportion of income spent on the commodity.
The goods on which the consumers spent a small portion of their income like tooth paste, shoe polish etc. will have inelastic demand. The goods on which the consumers spent a large part of income like cloth, scooter etc will have an elastic demand.
The 3D television and prescription are complementary goods. The change in price of one changes the demand for other. For example a rise in price of 3D television reduce its demand and as well as the demand for prescription. The demand for prescription depends upon the demand for 3D television. A change in price of 3D television changes the demand for prescription but not otherwise.
On the purchase of 3D television the consumers spent a large part of their income, since its demand is elastic. Again if we include the 3D television in the category of luxury goods its demand is elastic.
On the prescription the consumers spent a small fraction of income. It is neither luxury goods nor necessary goods. It is simply complementary goods. Without 3D television the prescription has no use.
To conclude by comparing the demand elasticity of both 3D television and prescriptions one would say that 3D television has a higher price elasticity of demand in absolute value.
2. Elasticity of supply is the responsiveness of supply to a change in price.
The determinants of elasticity of supply are:
1. The availability of substitute. If close substitutes are available elasticity of supply will be high and viceversa.
2. Excess capacity.
If excess capacity prevails in an industry the supply will be more elastic. The supply will be less elastic when there is limited excess capacity.
3. Time period: Supply is elastic during long period but it is inelastic in short period.
In case of coffee and electricity there is excess capacity in coffee sold in a café but there is limited excess capacity in electricity. Since the supply of coffee in the café can be expanded it has high price elasticity of supply in absolute terms.
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