ACKNOWLEDGEMENTS I would first like to express my immense gratitude to my lecturer, Mr.

Baboo Now butsing for his constant support and motivation that has encouraged me to come up with this assignment.I am also thankful to my family, friends and mates, who have rendered their whole hearted support at all times for the successful comple tion of the assignment question.

3 Table of contents Introduction to Demand . 2 Elastic and Inelastic Demand 2 Determinants of Price Elasticity of Demand 3 Conclusion .. .Page 1The meaning of Demand Elasticity .Page Page Page 4

4 Clearly illustrates giving examples the determinants of priceelasticity of deman d. Introduction to Demand Demand refers to the quantities of a product that people are prepared, willing a nd able to purchase over a given period of time at any prevailing price.The law of demand states that if everything else were to remain constant this is known a s ceteris paribus, as price falls, the quantity demanded rises. Similarly as pri ce increases, thecorresponding quantity demanded falls. There is an inverse rela tionship between price andquantity demanded. This relationship leads to the down ward sloping demand.The figure below shows a downward sloping curve:When a produ cts demand shifts, different quantities of a product are demanded at each andever y price. The determinants of products demand shifts are consumers tastes and pref erences,consumers income, the market size, prices of related goods, consumers expe ctations, the size of population and Government policies. T he meaning of Demand Elasticity The quantity demanded of a good is affected by changes in the price of the parti cular good,changes in price of other goods changes in income and changes in othe r relevant factors. In other words demand elasticity reflects the extent to whic h changes in the products price affect thequantity demanded by consumers. Elastic ity is a measure of just how much the quantitydemanded will be affected by a cha nge in price or income. 5 A ssume that the price of gas increases by 1 percent. If quantity demanded consequ ently falls by20 percent, then there is a very large drop in quantity demanded i n comparison to the change in price. The price elasticity gas would be said to b e very high. If quantity demanded falls by 0.01 percent, then the change in quan tity demanded is insignificant compared to the large change in price and the pri ce elasticity of gas would said to be low.Different elasticities of demand measu re the responsiveness of quantity demanded to changes inthe variables which affe ct demand. So price elasticity of demand measures the responsiveness of quantity demanded to changes in price in the price of the good. Income elasticity measur es theresponsiveness of quantity demanded to changes in consumer incomes. Cross elasticity measuresthe responsiveness of quantity demanded to changes in the pri

ce of another good. Economistscould also measure population elasticity, tastes e lasticity or elasticity for any other variablewhich might affect quantity demand ed, although these measures are rarely calculated. Price elasticity of demand R esponsiveness can be measured in terms of percentage. So price elasticity of dem and is theresponsiveness of changes in quantity demanded to changes in price is calculated by using theformula: Percentage change in quantity demanded Percentage change in price Elastic and inelastic demand Different values of price elasticity of demand are given different names. When t here is a smallchange in a products price resulting in a significant change in th e quantity demanded there iselastic demand. Demand is price elastic if the value of price elasticity is greater than one. If demand for a good is price elastic then a percentage change in price will bring about an evenlarger percentage chan ge in quantity demanded. For instance, if a 10 percent rise in the price of toma toes leads to a 20 percent fall in the quantity demanded of tomatoes, then the p rice elasticityis 2010 or 2 and therefore the demand for tomatoes is elastic. Dem and is said to be infinitelyelastic if the value of elasticity is infinity.In ad dition, when a change in a products price has only a slight effect on the quantit y demandedthere is inelastic demand. Demand is price inelastic if the value of e lasticity is less than one. If demand for a good is price inelastic then a perce ntage change in price will bring about a smaller percentage change in quantity demanded. For instance if a 10 percent rise in the price in the priceof commuter fares on British rail southern region resulted in a 1 percent fall in rail jour neysmade, then the price elasticity is 110 or 0.1 and therefore the demand for Br itish rail commuter traffic is inelastic. Demand is said to be infinitely inelas tic. 6 Demand is of unitary elasticity if the value of elasticity is exactly 1. This me ans that a percentagechange in price will lead to an exact and opposite change i n quantity demanded. For instance, agood would have unitary elasticity if a 10 p ercent rise in price led to a 10 percent fall in quantitydemanded.The figure bel ow illustrates how price elasticity and inelasticity and unitary elasticity can beshown in a graph:(a) (b) (c) A horizontal demand curve (a) is perfectly elastic whilst a vertical demand curve (b) is perfectlyinelastic. A curve with unitary elasticity (c) is a hyperbola with the formula PQ=k where P i s the price, Q is the quantity and k is a constant value. T he determinants of price elasticity of demand The exact value of price of price elasticity of demand for a good is determined by a wide varietyof factors. Economists however, argue that two factors in parti cular can be singled out: theavailability of substitutes and time. T he availability of substitutes The better the substitutes for a product the higher the price elasticity will te nd to be. For instancesalt has few good substitutes. When the price of salt incr eases, the demand for salt will changelittle and therefore the price elasticity of salt is low. On the other hand spaghetti has many goodsubstitutes, from other type of pasta to rice potatoes, bread and other foods. A rise in the price of spaghetti all other prices remaining constant, is likely to

have a significant effect on the demandfor spaghetti. Hence the elasticity of d emand for spaghetti is likely to be higher than that for salt.The more widely th e product is defined, the fewer substitutes it is likely to have. Spaghetti hasm any substitutes but food in general has none. Therefore the elasticity of demand for spaghetti islikely to be higher than that for food. Similarly the elasticit y of demand of demand for boiledsweets is likely to be higher than that for conf ectionery in general. A 5 per cent increase in the 7 price of boiled sweets, all other prices remaining constant, is likely to lead to a much larger fallin demand for boiled sweets than a 5 percent increase in th e price of all confectionary. T ime Factor Furthermore, time is another determinant of price elasticity of demand. The lon ger the period of time the more price elastic is the demand for a product. For i nstance in 1973/74 when the priceof oil quadrupled the demand for oil was initia lly little affected. In the short term the demand for oil was price inelastic. T his is hardly surprising. People still needed to travel to work in cars andheat their houses whilst industries needed to operate. Oil had a few substitutes. Mot orists couldnot put gas into their petrol tanks whilst businesses could not chan ged oil-fired systems to run ongas, electricity or coal. However in the longer t erm motorists were able to and did buy carswhich were replaced by gas and electr ic systems. Businesses converted or did not oil firedequipment. The demand for o il fell from what it would otherwise have been. In the longer runthe demand for oil proved to be price elastic. It is argued that in the short term buyers are o ftenlocked into spending patterns through habit, lack of information or because of durable goodsthey have already been purchased. In the longer term, they have the time and opportunity tochange those patterns. Necessities and luxuries Moreover it is argued that necessities have lower price elasticities than luxuri es. Necessities bydefinition have to be bought whatever their price in order to stay alive. So an increase in the price of necessities will barely reduce the qu antity demanded. Luxuries on the other hand aregoods which are not essential to existence. A rise the price of luxuries should therefore produce a proportionately large fall in demand. There is no evidence, however, to suggest that this is true.Food, ar guably a necessity does not seem to have a lower elasticity than holidays or lar ge cars, both arguably luxuries. Part of the reason for this is that it is very difficult to define necessitiesand luxuries empirically. Some food is a necessit y but a significant proportion of what we eat isunnecessary for survival. It is not possible to distinguish between what food is consumed out of necessity and w hat is luxury. It is also sometimes argued that goods which form a relatively lo w proportion of total expenditure have lower elasticities than those which form a more significant proportion. A large car manufacturer, for instance, would continue to buy the same amount of paper clips even if the price of paper doubled because it is not worth its price while to bother changing to an alternative. On the other hand, its demand for s teel would be far more priceelastic. Conclusion Ultimately, determining the concept of price elasticity of demand has an extraor dinarily widerange of applications in economics. In particular, an understanding of price elasticity of demandis useful to understand the dynamic response of de

mand in a market, to achieve an intendedresult or avoid unintended results.