Demand is one of the key concepts in economics. It depends on many factors: the price of the product, consumer income, the availability of substitutes, the quality of the product and the taste preferences of the buyer. The greatest relationship is found between demand and the price level. The price elasticity of demand shows how much consumer demand has changed when the price increases (decreases) by 1 percent.
Instructions
Step 1
Determining the elasticity of demand is necessary for making decisions about setting and revising prices for goods and services. This makes it possible to find the most successful course in the pricing policy of the enterprise in terms of economic benefits. The use of data on the elasticity of demand allows us to identify the consumer's reaction, as well as direct production to the upcoming change in demand and adjust the occupied market share.
Step 2
The price elasticity of demand is determined using two coefficients: the coefficient of direct price elasticity of demand and the coefficient of cross-price elasticity of demand.
Step 3
The coefficient of direct price elasticity of demand is defined as the ratio of the change in the volume of demand (in relative terms) to the relative change in the price of the product. This coefficient shows how many percent increased (decreased) demand when the price of goods changes by 1 percent.
Step 4
The coefficient of direct elasticity can take several values. If it is close to infinity, then this indicates that when the price decreases, the demand of buyers increases by an indefinite amount, but when the price rises, they completely abandon the purchase. If the coefficient exceeds one, then the increase in demand occurs at a faster rate than the price decreases, and vice versa, demand decreases at a faster rate than the price increases. When the coefficient of direct elasticity is less than one, the opposite situation arises. If the coefficient is equal to one, then the demand grows at the same rate as the price decreases. With the coefficient equal to zero, the price of the product has no effect on consumer demand.
Step 5
The coefficient of cross-price elasticity of demand shows how much the relative volume of demand for one good has changed when the price changes by 1 percent for another good.
Step 6
If this coefficient is greater than zero, then the goods are considered fungible, i.e. an increase in prices for one will invariably lead to an increase in demand for another. For example, if the price of butter rises, the demand for vegetable fat may increase.
Step 7
If the cross-elasticity coefficient is less than zero, then the goods are complementary, i.e. with an increase in the price of one product, the demand for another decreases. For example, when the price of gasoline rises, the demand for cars falls. If the coefficient is equal to zero, the goods are considered independent, i.e. a perfect change in the price of one good does not affect the amount of demand for another.
