question_answer

The demand for good rises by 20 percent as a result of all in its price. Its price elasticity of demand (-) 0.8. Calculate the percentage fall in price.                                                                                      [4]

Or

How is price elasticity of demand affected by?

(i) Number of substitutes of available for the good,

(ii) Nature of the good

Answer:

\[{{E}_{d}}=\frac{\text{Percentage}\,\,\text{Change}\,\,\text{in}\,\,\text{Quantity}\,\,\text{Demanded}}{\text{Percentage}\,\,\text{Change}\,\,\text{in}\,\,\text{Price}}\]

or,        \[0.8\,=\frac{\text{20}}{\text{Percentage}\,\,\text{Change}\,\,\text{in}\,\,\text{price}}\]

Thus, the percentage fall in the price = \[\frac{20}{0.8}=25%\]

Thus, the percentage fall in the price 25.

Or

(i) Number of Substitutes Available for the Good: The demand for a good that has more number of substitutes available will be relatively more elastic and ed > 1. This is because a slight increase in the price will push the consumers to shift their demand away from the good to its substitutes. On the other hand, with a slight fall in price the consumers would shift their demand from the substitutes towards the good. Thus, the goods having a large number of close substitutes will have elastic demand. On the contrary, if a good has no close substitutes, then it will have an inelastic demand.

(ii) Nature of the good: The price elasticity of demand depends on the nature of a good. The goods and services can be broadly divided into three categories - Necessities, Luxuries, Jointly-demanded goods. The three types of goods have different values of elasticity as discussed below.

(a) Necessity goods: These goods are those goods which a consumer demands for sustaining his life. A consumer cannot reduce the consumption of these goods. The demand for such goods does not change much in response to the changes in their prices. Even when the price rises the consumer cannot reduce their demand. Hence, such goods have an inelastic demand (ed < 1).

(b) Luxury goods: Luxuries are the good which are not essential, rather, are consumed for leisure or comfort purposes. For example, air conditioner, branded garments, etc. The demand for such goods is highly responsive to changes in their prices. A rise in the price, reduces the demand for them and vice-versa. Thus, such goods have high price elasticity.

(c) Jointly-demanded goods: Jointly-demanded goods are those goods that are demanded together. The joint consumption of such goods collectively satisfies wants. For example, sugar and tea. A rise in the price of one good does not reduce its demand if the demand for its complement good has not reduced. For example, a rise in the price of sugar will not reduce its demand if the demand for tea has not decreased. Hence, such goods have an inelastic demand (ed< 1).