Types Of Price Elasticity Of Demand Essay

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:

1.Price elasticity refers to the change in quantity demanded to the change in price. When the demand for the good is inelastic, an increase in the price level will result increase in the revenue. On the other hand, in case of elastic demand the price level will lead to a decrease in the revenue. The producers will set higher price for the products having inelastic demand. On the other hand, the producers will charge lower price for the products with elastic demand. It is important to know the price elasticity of demand upon which a producer can decide its optimum price level to meet the desired revenue (Baumol & Blinder, 2015). It will help the producer to specify what amount of increase in the price level will be optimal for the firm. Price elasticity of demand will also help the producer in setting the marketing strategies and setting the targeted segment. Thus, it is important for the producers to have a proper knowledge of price elasticity before setting the price of the product (Thimmapuram & Kim, 2013).

Fig 1- Different types of price elasticity of demand

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In figure A, in case of perfectly elastic demand, it is seen that the price remains constant for different quantities of the good. In fig B, it is seen that the consumers are ready to pay any price for the same quantity of product. This is the case of perfectly inelastic demand.

2.The theory of absolute advantage by Adam Smith and comparative advantage by David Ricardo are the two important theories of international trade. The theory of absolute advantage states the capacity of a country to produce per unit of the goods at a cheaper cost. On the other hand, the theory of comparative advantage analyses the capacity of the country to produce the goods at low opportunity cost.

The theory of absolute advantage highlights the country that is specialized in the production of that particular good will only be benefited. However, the theory of comparative advantage states that trade is beneficial for both countries. They measure the efficiency in production in terms of relative magnitude. Moreover, with the required amount of resources, the theory of absolute advantage allows the country for the production of higher volume of goods. On the other hand, the theory of comparative advantage with the same amount of resources allows the country to produce goods that are better than the other country (Krugman, Obstfeld & Melitz, 2015).

Country

Wheat(in kg)

Cloth(in metre)

Poland

6

1

Australia

4

3

Total(excluding trade)

10

4

Fig 2 -Absolute Advantage Theory

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Poland has absolute advantage in the production of wheat (6>4). On the other hand, it has comparative advantage in the production of wheat as it can give 1/6 meters of cloth in comparison with Australia giving up ? meter of cloth. On the other hand, Australia has absolute advantage in the production of cloth (3>1). It also has comparative advantage in the production of cloth as it gives up 1.33 kg of wheat by producing cloth where Poland gives up 6 kg (Laursen, 2015). This is shown in figure 4 and 5 respectively.

Country

Wheat(in kg)

Cloth(in metres)

Poland

12

0

Australia

0

6

Total with specialization and trade

12

6

Fig 3- Absolute Advantage (Gains from Specialization)

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Fig 4- Absolute Advantage Theory Fig 5 -Comparative Advantage Theory

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Reference List

Baumol, W. J., & Blinder, A. S. (2015). Microeconomics: Principles and policy. Cengage Learning.

Krugman, P., Obstfeld, M., & Melitz, M. (2015). International Trade: Theory and Policy: Global Edition. Pearson Higher Ed.

Laursen, K. (2015). Revealed comparative advantage and the alternatives as measures of international specialization. Eurasian Business Review, 5(1), 99-115.

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.

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