Question

< 10 B #105 Elasticity concepts a... 1. In Modules 8 and 9 we discussed the concept of price elasticity'---that is, why some Demand curves are price 'inelastic' while other Demand curves are price elastic'. 1. What are the forces that determine why some Demand curves are elastic while others are inelastic"? 2. Why is the Demand curve for gasoline considered to be inelastic while the Demand curve for one type of 'typical' new car is considered to be elastic"? 3. Is the Demand curve for coffee price inelastic? Or price elastic? Why? Please apply the forces discussed in question #1 to your analysis. 4. Do the same analysis for the Demand for a typical loaf of bread, a $50 per person meal, and a pack of cigarettes. 5. Not so long ago, voters in our state passed a law raising the tax on a pack of cigarettes by $2. Let's say that as a result, the price of a typical pack went up from $5 to $7 per pack. If the quantity of packs purchased each day at $5 was 5 million packs per day in our state, predict what happened to quantity purchased when the price rose to $7 per pack. 6. Name a product or service that is completely new—not discussed in the Modules or the text. What is the price of this product or service)? What is the quantity sold per year? (you may estimate this). IS THE DEMAND FOR THIS PRODUCT OR SERVICE (PRICE) ELASTIC? OR INELASTIC? WHY? What would happen to the quantity purchased of this product if the price were to rise by 10%? Why? 7. In Module #2 we discussed the idea that Coke and Pepsi demonstrate a high "CROSS" (price) elasticity measure. What does this mean, exactly? 8. In theory, if Coke were to raise its price by 5%, how would this affect the Demand for Pepsi? Why? 9. In theory, if Coke were to LOWER its price by 5%, what would happen to the Demand for Pepsi? Why?

Answer 1

Answers 1; 2; and 3.) Before we delve into the forces that determine the elasticity and inelasticity of demand we need to define what is price elasticity of demand. In simple terms, how demand and/or supply of a product reacts to a given change in prices of that product defines the price elasticity of demand.

Put in a formula, the price elasticity of demand is defined as:

Price Elasticity of Demand = % Change in Quantity Demanded / % Change in Price

If the quantity of a good demanded changes more than the price change, the product is termed elastic. Mostly goods that have substitutes such as Coke or Pepsi; tea or coffee are generally elastic in nature. Thus, demand curve for coffee is elastic.

In case of elastic goods, when the price increases the demand decreases while, a fall in prices would result in increase in demand.

An inelastic good is one where people continue to buy irrespective of a change in market price. For instance, gasoline, insulin etc. where any increase in prices of these products does not have any effect on demand as they are non-substitutable or necessities. Thus, demand for gasoline is inelastic as people will need fuel for their vehicles. Whereas, demand curve for a new car is termed elastic as it is a discretionary good that a consumer can postpone if there is an increase in prices.

The forces that determine elasticity and inelasticity include, substitutability of products in case of elasticity (example, tea and coffee; chocolates and candies or ice cream); and necessities and/or discretionary nature of products in case of inelasticity (example, milk, gasoline, cigarettes and high-end cars or electronic items).

Answers 4; 5; 7; 8 and 9.) Demand for loaf of bread is inelastic as it is a necessary good and any increase or decrease in prices will not have an impact on consumer purchasing behaviour. For cigarettes, the demand is also inelastic as it is an addictive product where any change in prices will have no impact on its demand.

Regarding, Coke and Pepsi, an increase in price of Coke would reduce the demand for Coke while, demand for Pepsi would increase and vice-versa.

Answer 6.) Let us take an example of electronic item such as smart mobile phone. Its demand is elastic as any change in prices will have an impact on its demand/supply. This is a high-end product hence, a small change in prices would result in a huge fall in demand for mobile phone. Thus, a small change in prices of such luxury or high-end products will lead to drastic change in demand and supply from both consumers and producers.