Explain the concept of Price Elasticity of Demand and discuss its relevance for Business and Government.

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                Student Number: 2011432859

Explain the concept of Price Elasticity of Demand and discuss its relevance for Business and Government.

Assignment 1

Business Environments

Module: 26301

Tutor: Leigh Davison

Student Number: 2011432859


There are a several factors in a market economy that influences the purchasing decisions of consumers. One of the main factors is the price of the good or service, and the law of demand explains the general relationship between price and consumption where “the quantity of a good demanded per period of time will fall as the price rises and rise as the price falls, ceteris paribus” (Sloman et al, 2004). The price elasticity of demand expands on this concept and studies the degree of the change of quantity in relation to price. The extent of the change in demand in response to price changes is of significance to businesses and the government, and hence the various methods such as the total revenue method, arc method and point method have been used to assess the concept.

The price elasticity of demand measures the responsiveness of quantity demanded to a change in price and the most widely used method because of its simplicity is the percentage method (Begg, 2006). The elasticity of demand is calculated by dividing the percentage change in quantity demanded by the percentage change in price. Demand can be judged to be relatively elastic, relatively inelastic or unitary elastic and can be represented as a figure. It is common for all goods to experience an increase in demand from a decrease in price, however if the reduction in price leads to a more than proportionate change in quantity demanded, it is said that demand very sensitive to price changes. Therefore, the demand is relatively elastic and the price elasticity would be greater than one. On the other hand, if there has been a less than proportionate change in quantity demanded, it indicates that it is not very responsive to price changes; thus demand is relatively inelastic and the price elasticity would be between zero and one. Where the price and quantity demanded change by the same proportion, demand in this case is unitary elastic and will give elasticity equal to one. (Anderton, 2006)

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With the use of diagrams, there are two extreme cases of elasticities in addition to the three types discussed. These are perfectly price elastic demand and perfectly price inelastic demand and are the only cases in which by looking at the gradient of the demand curve, it is sufficient enough to identify the price elasticity of demand throughout the curve. It is easy to point out these two extreme elasticities, a perfectly price elastic demand is represented on a graph as a horizontal linear line and perfectly price inelastic demand as a vertical linear line.

In the situation ...

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