Demandcan be defined as ability and willingness to pay for the good orservice. Most of us desire to purchase or own more than we are ableto, however the demand definition states that it is the amount ofgood or service that consumers want to buy for a given price(Economics, 2009).Thelaw of demand says that, when other things are being equal, thedemand for a good will decline if the price is raised and rise if theprice is reduced, which can be showed in a graph A.
Thepicture above tells how many goods the consumer is willing to buy atgiven price. The demand curve is downwards sloping, indicating that ahigher price reduces the quantity of the good demanded. The demandcan be effect by few things. Not only the price of the particulargood effects the demand of that good, also the price of complementarygoods and price of substitutes, income levels and taste. Movementsalong the demand curve is caused by the price change, although theother factors are causing the shift of the demand curve, either tothe rights or to the left, depending which factor it is. Theresponsiveness of the quantity demanded to a change in the price ofthat good is called elasticity. Theelasticity lets us measure and interpret how decrease or increase ofthe price of the good, effects its demand. The price elasticity ofdemand, shorted PED, can be calculated with the formula:%change in Quantity demanded (Q)______________________________ %change in Price (P)Supposethat 20% increase in price of the good causes 40 % less of that goodwill be sold.
40% PED= ———– = 2.20%Theelasticity of that good is 2, which indicated that Price ofElasticity Demanded is elastic. The change in quantity demanded istwice as big a the change in the price. Because the quantity demandedof the good is negatively related to its price , the percentagechange in quantity will always have the opposite sign as thepercentage change in price. (Essential of Economics, 2015)Tocalculate the value of the PED we check which number is bigger andnot if it is a plus or minus sign before it. Thereis five meanings of the Elasticity Measurements. Price Elasticity ofDemand can be elastic, as showed in the example, which means thatdemand is responsive to a change in price. When 20% of the priceincrease causes 40% decrease of quantity demeaned.
The demand curveis elastic when the price change, fall or increase, causes meaningfulretraction in demand of that good. The value is elastic when priceelasticity of demand is less than 1. When small price increase causesbig decrease in quantity demanded means that good is very responsive(it is be demonstrated in the graph B)Whenthe value of the Price Elasticity of demand is more than 1, it meansthat the good is inelastic. Demand is not very responsive to thechange of price. Significant increase of price causes only small fallin demand. For example 40% increase of price causes only 10% decreasein quantity demanded.
(This behaviour is illustrated in the graph C)Whenthe Price Elasticity of Demand value equals 1, the good has unitelasticity. This situation happens when percentage change in quantitydemented is the same as percentage change in price. For example when5% increase of price will cause 5% decrease of quantity demanded. Thegood is perfectly inelastic when Price Elasticity of Demand equalszero. The change in price has no effect on quantity demanded, whichis illustrated as vertical demand curve.
ThePrice Elasticity of Demand is is Perfectly Elastic when equalsinfinity. It accrues when any change of price of the good causesquantity demanded fall to zero. In this situation the demand curve ishorizontal as presented in the graph below. CalculatingPrice Elasticity of Demand shows how total revenue changes when pricechanges. Increase of price does not necessary means increase of totalrevenue. Whenthe demand curve is inelastic (see graph below) an increase in pricecauses proportional fall in quantity demanded which leads to highertotal revenue. Price increase from €8 to €10 makes quantitydemanded decrease from 200 to 180.
In this case total revenue goes upfrom €1600 to €1800 Inthe case when demand curve is elastic, an increase in the pricecauses fall in quantity demanded. In this situation total revenuefalls. When price goes up from €8 to €10, quantity demandeddecreases from 200 to 80. Total revenue falls from €1600 to €800.
The term “price elasticity of demand” might not be very commonbut it is frequent used by firms, organisations and government indecision making. Knowledge of the basic law of demand is not enoughto decide about final price of the product or service. It has to bemeasured how change of the price will affect the final outcome.Publicpolicy making uses elasticity to imposes tax on goods likecigarettes, alcohol or petrol.Thoseproducts are inelastic, they have not many substitutes, are essentialor addictive.
When the price goes up, the quantity demanded does notfall significantly. Those goods are not responsive to a price change,which means demand will still be high regardless raised price. Oneof the examples of the use of the Elasticity of demand can be PriceReticulation and Crop Restriction of Farm Products used bygovernments of many countries. In United States of America theGovernment encourage farmers to limit agriculture production byoffering them grants. The demand of the farm products is inelasticand big supply of those products causes fall of the price whichlowers farmers incomes.
The government enacted policy restrictingfarm production and provides subsidy to those who keep their land notcultivated. This policy reduces supply in the market which causes theprice of those products rise. Agricultural products are inelastic andthe fall in production leads to increase of the revenue and farmersincomes. The graph aboveillustrates how farmers revenue equals to the OP1, E1,Q1. Afterimplementation of the Governments rules, supply shifts to the left.
(Supply curve is assumed to be perfectly elastic to simplify thecase). When agricultural products price increases to P2 and quantitydemanded decreases to Q2 the new revenue is OP2,E2,Q2 and it ishigher than what it was before governments regulations whichincreased farmers incomes.