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

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Introduction

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. ...read more.

Middle

For instance, if a country suffers from a famine due to crop failure and an increase in the population, an individual would be prepared to pay any price to obtain some food. Therefore, it is debatable whether the government should regulate markets that are vulnerable to such catastrophic events and the exploitation of consumers. Sloman et al (2004) explains that there are a variety of factors that can affect the price elasticity of demand, but there are only two factors that can be singled out and that is the availability of substitutes and time. If a good is widely available and has many close substitutes such as bread, will have a highly elastic demand. If the price of a particular brand of bread increases the demand for that good will decrease more than proportionately. This is because consumers can easily switch to another brand that they perceive to be of the same quality. If the good has little or no close substitutes available, such as petrol will have an inelastic demand and people will still buy close to a certain quantity regardless of price changes, so there will be little impact on the reduction in demand. Anderton (2006) explains that demand tends to be more price elastic in the long run rather than the short run. ...read more.

Conclusion

For example, they can charge higher prices in peak times and low prices in off-peak times, thus maximizing total revenue. If the market in question is monopolistic in nature, the same notion applies and the government is able to intervene and may propose a liberalization of the markets and closely regulate the prices to protect consumers from price fixing and exploitation. This in turn will make the intervened market more price competitive making demand relatively elastic. The subject of economics is classed as a social science and studies how individuals and groups make decisions to satisfy their wants and needs with the limited resources. In reality, consumers hold all the power in the decision-making and can purchase anything they desire. However, the price mechanism is a system where market forces of demand and supply set prices and the decisions made by producers and consumers. The price elasticity of demand broadens this concept by measuring responsiveness or sensitivity of the demand. This is important to businesses as they seek to maximize profits and the use of price elasticity of demand will determine the best pricing policy to use to achieve the objective. It is also important to government, as they need to determine the correct prices for their own goods and services offered as well as regulating the taxes levied on private goods and services. ...read more.

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