Managerial Economics, Coursework Example

Price Elasticity of Demand:

The price elasticity of demand measures the rate at which the quantity demanded of a product changes due to a change in price of that product. If the price elasticity of demand is between 0 and 1 then the demand is said to be price inelastic. At 1, it is unit elastic and at coefficients greater than 1, it is price elastic.

The more price inelastic a demand is, the steeper is the demand curve indicating that a certain percentage change in price will result in a smaller percentage change in quantity demanded. Similarly, a flatter demand curve indicates a relatively elastic demand curve which means that a certain percentage change in price will be accompanied by a larger percentage change in demand. When a demand is price inelastic, it pays to increase the price because a smaller percentage change in demand means the total revenue will increase in the case of price increase and vice versa. Similarly, when the demand is price elastic, raising prices will hurt and lowering prices will improve the total revenue.

The price elasticity of demand varies over a demand curve, both linear and non-linear. The range where price increase results in higher total revenue will be inelastic range, the range where price increase results in lower total revenue will be elastic range and the range where both upward or lower movement in price leaves the total revenue unchanged will be unit elastic range.

The factors that affect the price elasticity of demand are availability of substitutes, percentage of budget spent on a particular budget, nature of the product (necessity vs. luxury), and time duration. Given the factors just discussed, the demand for wheat is inelastic in UAE because wheat is one of the staple foods as a basic ingredient in Arabic pita bread. Wheat has no close substitutes and it takes a relatively small portion of most people total food budget. Similarly, the Mercedes Benz vehicles have elastic demand in UAE because they are luxury and can be do without. There are much cheaper cars that can provide the basic service of transportation. Similarly, high prices of Mercedes products mean that the customer can expect to spend a considerable chunk of his total wealth in buying a Mercedes as compared to popular and quite cheap entry level cars such as Honda Civic and Toyota Corolla.

Among telecommunication, hospital, and airline, hospital has the most inelastic price elasticity of demand. This is because hospitals provide as important basic necessity as health care services many of which are life-saving. There is no substitute for health-care services. Time becomes even more critical in case of emergencies where often the best option is to take the patient to the nearest hospital since every second counts. If people can afford it, they will usually go for the best hospital irrespective of costs. It’s true in UAE like any other country. Telecommunication has moderately inelastic demand curve because even though telecommunication is still the most efficient and preferred way of communication, substitutes exist even if they are not as good as telecommunication. Live talk is always time saving and convenient but emails, video conferences, and fax are some other ways of communication though each communication medium has its capabilities and limitations. In addition, messenger chat is also very popular among teens for being economic. Emails are usually free, thus, it is clear that telecommunication has some disadvantages against substitutes like email and messenger in terms of cost but the benefits of telecommunication outweigh the disadvantages.

Airline has the least inelastic demand curve of the three and its even truer in geographically small countries like UAE where the time benefits of airline travel tend to disappear against substitutes such as personal automobiles and trains. Airline travel is still the most convenient and fastest in UAE but the total travel time includes just not actual flight duration but also the time required to follow pre-flight procedures such as check-in, waiting, flight connections, and so on. In addition, airline travel is usually expensive than its substitutes and sometimes offers a lower value than other forms of travel. The airline travel may become more price inelastic in countries with vast geographical areas such as U.S. due to the time factor but for small countries like UAE that have great infrastructure as well as small geographical areas, there exist certain other reliable modes of transportations.

The least elastic service is hospital among the three because of the nature of the service hospital provide. The cross-price elasticity of demand measures the responsiveness of a quantity demanded to change in price of a related good. An example would be a change in the quantity demanded of personal automobiles in response to change in price of oil.

As far as hospitals are concerned, their substitute may include private clinics providing limited range of services and practitioner of traditional medicines. The cross-price elasticity of demand for substitute services such as private clinics and traditional medicine practitioners is going to be elastic because private clinics can only provide basic and limited services and don’t have the full range of services provided by hospitals many of which require complex and specialized equipments. Similarly, practitioners of traditional medicine do not employ scientific methods and rely on trial and error methods. Thus, they are not trusted by the majority of the population and usually appeal to old-fashion and poor customers. Thus, hospitals are not only more efficient, reliable, but also provide every service that a private clinic or practitioner of traditional medicine can provide. Because hospitals are perfect substitutes for private clinics and traditional medicine, the cross-price elasticity of demand for hospital substitutes will be elastic.

For complementary products, the cross-price elasticity of demand will be inelastic because complementary products may include specialized X-ray services, blood-test clinics etc. in case the hospitals don’t have them. If the hospital may require such tests from the patients, the patients will have little choice but to obey. Thus, due to their close association with hospitals, complementary products will enjoy inelastic cross-price elasticity of demand.