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Price Elasticity and Income Elasticity of Demand

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1. It is often observed that the price elasticity of demand for primary commodities is relatively low while that of manufactured goods is relatively high. Using diagrams, explain why. [10 marks] The PED of primary commodities (materials in a raw or unprocessed state) are generally low or that they are inelastic. This means that the % change in demand is lower than the % change in price or that demand won?t change by a large degree if price changes. This can be seen in figure 1.1. On the other hand, the PED of manufactured goods is relatively high or that they are elastic. This means that the % change in demand is higher that the % change in price. A change in price would result in a big change in demand which can be seen in figure 1.2. ...read more.


Lastly, wheat is consumed immediately ? in the short term. This means that wheat, or primary commodities, are inelastic because products that are consumed in a short amount of time tend to be more inelastic. Manufactured goods, on the other hand, such as laptops, are elastic in nature. Nowadays, laptops have a relatively high amount of close substitutes. For example, the gaming aspect of laptops could be replaced with gaming consoles. In this case, there is a choice for consumers to change what they buy. This means that if the price of laptops increase, consumers could switch to different, alternative products. Also, manufactured goods tend to be more of a luxury than a necessity. A huge increase in price will result in a significant decrease in demand. ...read more.


The decrease from P1 to P2 resulted in a much lower increase in demand (Q1 to Q2). In this case, total revenue fell. Equally, if price increases from P2 to P1, it will result in a much lower decrease of demand (Q2 to Q1) and total revenue would rise. If a product is price elastic, an increase of price would lead to a bigger percentage of decrease in demand ? causing total revenue to fall. Oppositely, if price decreased, demand would increase by a bigger percentage. This would increase total revenue. Figure 1.2 (Elastic = 1 < PED < Infinity) If price falls from P1 to P2, QD would increase by a bigger percentage from Q1 to Q2 and total revenue rises. Conversely, if price increases, it would lead to a fall in total revenue. A rise in price from P2 to P1 would a bigger decrease of demand. In this case, total revenue decreases. ...read more.

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