Applied Economics Market Pricing PDF

Applied Economics Quarter 3 – Module 4 The degree of elasticity of different products vary for several reasons. For the customers and suppliers, the common determinant of the quantity demanded and supplied is the price. During the discussion of the law of demand and the law of supply, it was disc...

Applied Economics Quarter 3 – Module 4 The degree of elasticity of different products vary for several reasons. For the customers and suppliers, the common determinant of the quantity demanded and supplied is the price. During the discussion of the law of demand and the law of supply, it was discussed that as the price increase the quantity demanded by the customers decrease and quantity supplied by the sellers increases. Do you think what is stated in the law of demand and supply always applicable? If it is applicable, is the change in quantity demanded for several products still the same? Does it mean that if the price increase by 1 % the demand will decrease by 1 % and the supply increases by 1 % also? To answer these questions, it is important to understand the reactions of customers and sellers to the change in price of different products. The reactions of the customers vary and so with the elasticity. The higher the change in quantity demanded compared to the change in determinants the more elastic is the product. Price elasticity of demand measures the change in demand in response to the change in price. For example, the price of pork increases by 5 % the price elasticity will be determined by identifying the percentage of decrease or increase in demand due to the change in price. To compute the price elasticity (ep) of demand the formula is: Where: Q1 = the original quantity demanded Q2 = the new quantity demanded P1 = the original price P2 = the new price To illustrate, let us have us have the following example. The two examples show that at different price and quantity combination the price elasticity coefficient may not be the same, a proof that the customers’ reaction to price changes vary. The percentage change in quantity demanded is greater than the percentage change in price. It has more than 1 elasticity coefficient. It means that if the price will increase there is a greater possibility that the consumer will not buy the product or may decrease the quantity of the product to buy. The percentage change in quantity demanded is lesser than the percentage change in price. It has less than 1 elasticity coefficient. It means that the decision of the consumer to buy the product is not that affected by the increase or decrease in price. The seller cannot assume that the consumer will buy more if they will decrease the price since the change in quantity demanded is only minimal. The percentage change in price is equal to the percentage change in quantity demanded. The elasticity coefficient is 1. It means that if the price increase by 1 % the demand will decrease by 1 % also and vice versa. When at the same price, the change of demand is infinite. It means that a small change in price may cause a huge change in demand. When there is no change in demand despite of the changes in price. Elasticity coefficient is zero. It means that the demand is not affected by price at all. The demand will still be the same even if there is an increase or decrease in price. Considering the two examples above let us interpret the elasticity coefficient that we derive. In example 1, the price elasticity coefficient is -0.3. It is inelastic, which means that for every 1 % change in price there will be 0.3 % change in demand. The change in price cause a minimal change in demand. In example 2. The price elasticity coefficient is 0. It is perfectly inelastic. The change in price does not affect the demand. In interpreting the price elasticity coefficient, we ignore the negative sign. It is negative because the price and demand is inversely related. Price is the main determinant of supply. Its elasticity describes how the producer or seller reacts or respond to the change in price. Where: Qs1 = the original quantity supplied Qs2 = the new quantity supplied P1 = the original price P2 = the new price Demand elasticity can also be determined by: A. Income elasticity which measures the change in demand in response to the change in income of the customers. The formula for income elasticity (ey) is: For example: An employee who earns P20,000 monthly can afford to buy his favorite milk tea almost 3 times a week but because of the pandemic in which most of the employees are affected, they are now reporting to their work 3 days a week only instead of 5 days. His income is affected and so with their expenses. Instead of their regular monthly salary, he receives P12,000 monthly. The purchase of his favorite milk tea also reduced to once a week only. For this example, the income elasticity coefficient shows that it is elastic. The income really affects the demand for that particular product. B. Cross price elasticity which measures the change in demand for a good in response to the change in price of related (substitute or complementary) goods. The formula for cross price elasticity (ec) is: Note: For quantity demanded (QD) consider the quantity demanded for Good A and for price, the change in price of another good (Good B). Example: The price of Product B increases from ₱35.00 to ₱42.00 which cause some of its consumer to decide buying Product A, its substitute. The demand for Product A increases from 500 units to 650 units. The cross elasticity of 1.5 shows that it is elastic. It means that a change in price of a related good can cause a change in demand for another good. Prepared by: Jheralyn Colorada 12 - GATES