Principles of Microeconomics

Rozenblat Oleg (Business Economics) 0902619

Essay (Week 4)

Topic: "What are the principal determinants of price elasticity of demand and what are the implications for government taxation?"

The price elasticity of demand (PED) measures how responsive the quantity demanded of a good is to a change in its price. More specifically the price elasticity of demand is the percentage change in quantity demanded respectively to a percentage change in price. In market analysis it enables to calculate the effect of a change in price, revenue, approximate sales and supply of a particular good or service. The value of PED illustrates if the good is more elastic (If PED is greater than 1) or inelastic (PED is less than 1).

Price elasticity of demand

=

percentage change

in quantity demanded percentage change

in price

However, in a forecast it's not so easy to calculate the PED because over the period of time other economical factors are constantly changing such as national income and consumers taste. So, for a prediction, economists assume that other things being equal. Ceteris Paribus. Price elasticity of demand is determined by a numerous factors. The main one is availability of substitutes. As far as a market is highly competitive there will be a lot of close substitutes to a particular product, so PED is more likely to be elastic because if price for a particular good increases, customers will be able to shift to alternative good which would provide the same quality and value for money. (LAW OF DEMAND.) For example, if price of COCA-COLA increases customers are likely to buy more of close substitutes, Pepsi. On the other hand, if there are a few businesses to provide similar products and there is a lack of choice for consumers, usually related to necessities with very inelastic supply, PED is likely to be inelastic because change in price will not have much effect on the quantity demanded of a particular product. For example, oil and gas. There are a few substitutes but its essential good for a customer. Therefore, if price changes dramatically, quantity demanded will not change much.
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However, some economists would argue that almost every product with even one substitute has a turning point and if price goes beyond this point PED may switch form inelastic to elastic in the long run. For example, PED of Microsoft Windows software considered to be inelastic. If price for Microsoft software increase very much, over the period of time, current and potential users will switch to APPLE Macintosh, because they offer a close substitute point which is available for sale. (ECONOMICS: UNIAN NEWS, UKRAINE)

Other thing that influences the Price elasticity of demand is income of the ...

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