Price Elasticity of Demand Modeling-Free-Samples for Students

Questions: 1.As a producer, why is it important to consider the price elasticity of demand of your product when setting the price you are going to charge? 2.Explain the difference between Comparative advantage an absolute advantage. Answers: Price elasticity of demand (PED) helps producers understand the impact of price responsiveness of consumers on profit and total revenue yielded from sales. Depending on the responses made by consumers for one unit change in price, sellers design their pricing strategy. Profit maximization theory under monopoly market and diagrammatical relation between PED and total revenue have been applied here to determine how PED influences the producers in the market with respect to the prices they opt to charge. Total revenue and profit maximization are two broad concerns of producer that stem from changes in price charged by him. According to the theory, PED depicts the percentage change in quantity demanded by the consumer to the percentage change in the price ( Rios Brue, 2013). Ed = ; - Ed 0 Based on general consumer behavior kinds of PED observed and their subsequent impact on total revenue are discussed below: Perfectly Price Inelastic: Quantity demanded is unchanged for unit price change implying Ed=0. In such case total revenue (TR) increases as producer is able to sell same quantity like before but at hiked price and TR decreases for one unit fall in price Medicine can be one good example where no matter what is the hike or fall in price people will buy the same amount (Thimmapuram Kim, 2013). Relatively Price Inelastic: In this case since -1 Ed 0 , unit hike in price would cause demand to fall less than one unit leading to hike in TR and vice-versa. Unitary Price Elastic: Here Ed=-1 implying percentage of change in demand the same amount of the percentage change in price. TR remains unaffected as the price and quantity change cancels out each other. Relatively price Elastic: Here - Ed -1 which means if price increases by one unit then quantity demanded falls by more than one unit yielding declining TR and vice-versa for fall in price (Dixon et. al, 2012). Perfectly Price Elastic: Ed= -indicating any miniscule change in price would make the numerator infinite dropping to Q=0 (in case of price hike) and vice-versa. Since consumers will totally cut the purchase no TR is obtained hence TR=0. Fig-1 Relation Between PRICE Elasticity of Demand and Total revenue Coming to the Monopoly market where P MR suggests that producer enjoys discretion over market force in order to set final price. A monopoly seller produces optimum if MR=MC, that is the additional amount producer receives for one unit increase in the sale of a good must have to be equal to the cost made to produce such. Now, MR=P (1+1/ Ed) Or, MC= P (1+1/ Ed) Or, P=MC ( For perfectly inelastic demand scenario Ed = = 0 implying indicating infinite power of the monopolist to charge any price he wants. Contrast t this is perfectly elastic demand where he has no power over price since leading to P=MC, a competitive market case. In case of relative inelastic demand PMC where producer has some discretion to charge higher price since consumer responses less to the price change. Comparatively relatively elastic demand on the other hand leads to PMC indicating more response to the price change. From the above analysis it is evident how price responsiveness of the consumers measured by PED affects the total revenue that is acquired by the producers. Analysis of monopoly market gives a clear existence of the relation of pricing with that of PED. In order to extract higher total revenue and higher profit by setting price at the higher level than competitive market price level, producers should target the goods that have perfect or relative price inelasticity. 2.The concepts of absolute and comparative advantage are of intriguing importance in order to explain the driving factors behind international trade. Resources and endowments of nations differ with respect different geographical, demographical, political and economic factors. Not only the availability of resources but also the productivity and applicability of resources differ country to country. Divergence in the resource productivity is reflected in the diversity of production volumes among nations and all these bring forth the importance of specialized production and trade (Levchenko Zhang, 2016). According to David Ricardo who propounded the Comparative Advantage notion, it is better for the interest of two countries to produce not all goods but produce the one in which it has lower opportunity cost of production and involve in free trade. It should export the good produced in return of importing the good it has higher opportunity cost from another nation. Having comparative advantage in producing X implies that the amount of Y production forgone is less in order to increase one unit X production. The concept involves two country, two goods and two inputs labor and capital (Schumacher, 2012).. On the other hand, absolute advantage indicates the capability a nation has for producing a good at higher volume given both nations have same resources. This theory as developed by Adam Smith, focuses only on labor as input and describes the difference in labor productivity as the driving factor behind trade between nations. Required Labor Hours Per Unit of Production Before Specialization COUNTRY X Y A 80 120 B 100 90 Table-1 Country A requires less labor hours for one unit production of good X than Country B implies it has absolute advantage in X production. Similarly Country B has absolute advantage n Y production. If both countries focus on production of only the goods in which it has absolute advantage and trade it for the other good then they can consume both the goods in more amounts at cheaper price compared to autarkic condition Required Labor Hours Per Unit of Production After Specialization COUNTRY X UNIT PRODUCED ( X) Y UNIT PRODUCED (Y) A 80+120 2.5 0 0 B 0 0 90+100 1.9 Table-2 References Dixon, P. B., Bowles, S., Kendrick, D., Taylor, L., Roberts, M. (2012).Notes and problems in microeconomic theory(Vol. 15). Elsevier. Levchenko, A. A., Zhang, J. (2016). The evolution of comparative advantage: Measurement and welfare implications.Journal of Monetary Economics,78, 96-111. Rios, M. C., McConnell, C. R., Brue, S. L. (2013). Economics: Principles, problems, and policies. McGraw-Hill. Schumacher, R. (2012). Adam Smith's theory of absolute advantage and the use of doxography in the history of economics.Erasmus Journal for Philosophy and Economics,5(2), 54-80. Thimmapuram, P. R., Kim, J. (2013). Consumers' price elasticity of demand modeling with economic effects on electricity markets using an agent-based model.IEEE Transactions on Smart Grid,4(1), 390-397