Usefulness of cross elasticity of demand. Why Is It Valuable for a Business to Know the Cross Elasticity of Demand? 2019-01-07
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Understanding Cross Elasticity of Demand
. Thus, the negative value of cross elasticity of demand indicates that the products are from different industries. Bargaining capacity of trade unions depend upon elasticity of demand for workers services. The cost of production of these goods is also joint. Profit is the difference between the total revenue and the total cost, so profits may not increase if the cost exceeds the revenue. Therefore higher price elasticity elastic demand indicates higher consumer power and lower price elasticity indicates lower consumer power in the market.
Economics: Uses or Importance of Cross Elasticity of Demand
The demand curve is plotted on a graph with price labeled on the y-axis and quantity labeled on the x-axis. The concepts of demand elasticities include the price elasticity of demand, the income elasticity of demand, and the cross elasticity of demand. Luxuries on the other hand tend to have elastic demand curves. Incidence of Taxation: Incidence of tax lies on the person who ultimately pays the tax. Businesses must therefore make pricing decisions based on these elasticity assumptions. Other products have a low cross elasticity of demand.
It should be noted that because of interrelationship of firms and industries between which cross price-elasticity of demand is positive and high, any one cannot raise the price of its product without losing sales to other firms. Different products exhibit different elasticities, which in turn has an influence on a firm's pricing decisions. This is because consumers will always opt for the cheaper alternative, which in this case is the initial good, thus quantity demanded for its substitutes will decrease. This is often the case for different product substitutes, such as tea versus coffee. Your customers must buy at your price or forgo the item. Practical usefulness of elasticity of demand 01 To Formulate Government Policies In designing public finance policies Price elasticity of demand is very useful as an analytical tool in implementing of effective public finance policies. This results in a high positive cross price elasticity.
However, incremental price changes to goods with substitutes are analyzed to determine the appropriate level of demand desired and the associated price of the good. Very few smokers give up smoking because of price increases; most give up for health reasons. However, by convention, price elasticity is expressed as a positive number. Described below are its few applications in business sector. An elasticity of between zero and one is said to be relatively inelastic, when large changes in price cause small changes in demand.
Cross Elasticity of Demand: Importance and Numerical Problems
Unrelated goods are items that do not share similar characteristics or are purchased or used together. An industry is defined as a group of firms producing similar products that is, products with a high positive cross elasticity of demand. A negative cross elasticity denotes two products that are , while a positive cross elasticity denotes two products. Analyzing the Price Elasticity of Demand After calculating the price elasticity of demand, one of five results may be obtained. The policy of devaluation would be benificial when demand for exports and imports is price-elastic. The number and answer from our formula can help us determine the relationship and how certain products interact with each other. This is reflected in the cross elasticity of demand formula, as both the numerator percentage change in the demand of tea and denominator the price of coffee show positive increases.
So if price of ball pen increases people will simply go for ink pen. In drawing the demand curve, D 1D 1 for good X, it is assumed that the prices of other goods including good Y remain the same. In this case, pillows, mattresses and sheets would be good items to mark down because they have a negative cross price elasticity. The elasticity of demand is related to the slope of the demand curve, but is not the same. Sometimes, economists also like to know the cross price elasticity of demand which is how responsive or elastic the quantity demanded for a good is in response to a change in the price of another good. The producer will be guided mostly by demand and its nature while fixing his price. Very often demands for two goods are so related to each other that when the price of any of them changes, the demand for the other good also changes, its own price remaining the same.
In Price Determination of Factors of Production: The concept of elasticity for demand is of great importance for determining prices of various factors of production. If they want to tax a certain product, they'd better tax the more inelastic ones, because consumption will be reduced only a little. In general, for items having inelastic demand, the producer will fix a higher price and items whose demand is elastic the businessman will fix a lower price. Similarly, for price stabilization and the purchase and sale of stocks, information about elasticity of demand is most useful. And, cross elasticity is lesser than zero when rise in price of commodity Y causes fall in demand of commodity X. It all depends on the nature of the goods you're examining. The elasticity concepts are also limited as they only reflect the revenue for the firm.
Classification of Market: Market structure has been classified by prof. On the other hand, when the two goods are complementary with each other just as bread and butter, tea and milk etc. Thus, the knowledge of elasticity of demand is essential for management in order to earn maximum profit. This index can be really useful for governments. Comparatively there should be elastic demand for the good to provide higher margin of benefit for produces in granting a subsidy. The use of machines may reduce the cost of production and price. The demand for a certain good is elastic if the percent change in the demand of the good is larger than the percent change in the price of the good.
