Question

Explain what elasticities are and how can they be used in CBA?

Answer 1

Elasticity is an economic concept used to measure the change in the aggregate quantity demanded for a good or service in relation to price movements of that good or service. A product is considered to be elastic if the quantity demand of the product changes drastically when its price increases or decreases. Conversely, a product is considered to be inelastic if the quantity demand of the product changes very little when its price fluctuates.

For example, insulin is a product that is highly inelastic. For diabetics who need insulin, the demand is so great that price increases have very little effect on the quantity demanded. Price decreases also do not affect the quantity demanded; most of those who need insulin aren't holding out for a lower price and are already making purchases.

On the other side of the equation are highly elastic products. Bouncy balls, for example, are highly elastic in that they aren't a necessary good, and consumers will only decide to make a purchase if the price is low. Therefore, if the price of bouncy balls increases, the quantity demanded will greatly decrease, and if the price decreases, the quantity demanded will increase.

B. Elasticity affects cost benefit analysis because:

Cost benefit analysis is considered with estimating all the cost benefits of the investment as well as alternatives and then taking a decision based on the analysis. Elasticity affects this process because on analysis of the alternatives and the investment, you may realise that given the benefit it provides, you are not willing to invest. You may find out that you do not want to take the risk of investing for reasons like

Price fluctuations

Inflation

Risk

Decrease in purchasing power of money

And many other reasons