WHAT IS PRICE ELASTICITY OF DEMAND? According to McConnell, Brue & Flynn the law of demand states that other things being equal consumers will buy more of a product when its price declines and less when its price increases. The responsiveness of consumers to a price change is measured by a products price elasticity of demand. In economics, the demand for a certain good or service is represented by the demand curve. The demand curve is plotted on a graph with price labeled on the y-axis and quantity labeled on the x-axis.
When prices have a large impact on the demand of a product it is said to be elastic in demand. For example, a fall in price would lead to an increase in demand and an increase in price would lead to a fall in demand. On the other hand if the same situation led to a less than proportionate change in quantity demanded, than it can be said that the product is inelastic in demand. If the proportionate change in quantity demanded is equal to the proportionate change in price, the demand is unit elastic. There are many ways to measure the price elasticity of demand however the easiest way to do it is by comparing the change in price to the total revenue earned by the producer, known as the total outlay method.
The opposite occurs for a balance of payments surplus. However, the extent to which this occurs depends on the price elasticity of demand for exports and imports on the Marshall Lerner Condition. This condition states that devaluation (a fall in the value of the currency) will lead to an improvement on the current balance will be seen if the combined elasticities of demand for exports and imports are greater than 1. The size of any J-curve affect in the short run will also affect this extent. The J-curve effect is a short term
There are a number of factors effecting price elasticity of demand, the overriding determinant being the availability of substitute goods to the consumer, the more that are made available, the higher the elasticity is likely to be as buyers can easily switch from one product to another. Necessity of the good or product is another factor, the more necessary the product is to the consumer the lower elasticity as they will attempt to purchase no matter how much the price fluctuates. Brand loyalty, consumer income, along with peak and off peak pricing are also contributory factors of PED. The price elasticity of demand tells us what happens to total revenue when price changes. When demand is inelastic, a rise in price leads to a rise in total revenue and when demand is elastic total revenue rises when price falls.
In contrast, if there is not active market, market value accounting requires the use of estimation subject to uncertain assumptions, personal judgment, and subjective information about future values, such as discount rates and allowance for doubtful accounts. FASB has broadened the framework and disclosure practices to increase the reliability of market value accounting. However market value accounting is still emphasize the role of managerial judgment in the valuation process. Besides, market value accounting offers management the opportunity to manipulate the bottom line. So it’s less reliable than historical costs.
The long run average cost curve is explained by the economies of scale, and diseconomies of scale. It explains why LRAC goes down, and then goes up.As production increases, there are two basic influences at work: Economies of scale, and Diminishing marginal returns.Economies of scale cause average cost to decrease as production increases.Diminishing marginal returns causes average cost to increase as production increases. If Economies of scale outweighs diminishing marginal returns at low volumes, and eventually diminishing marginal returns outweighs economies of scale at high volumes the curve will be a U shape. A typical average cost curve will have a U-shape, because fixed costs are all incurred before any production takes place and marginal costs are typically increasing, because of diminishing marginal productivity.There is an indication of economies of scale if marginal costs are below average costs and average costs decreasing as quantity increase. An increasing marginal cost curve will intersect a U-shaped average cost curve at its minimum, after which point the average cost curve begins to slope upward.
-Define cross elasticity of demand and using diagrams explain what determines whether cross elasticity is positive or negative? Cross elasticity of demand is the measure of the responsiveness of demand for one good to a change in the price of another good. It tells us if demand increases or decreases with a change in price of another commodity. Cross elasticity demand tells us two things it determines the positive or negative change. Second is the value of the cross elasticity of demand.
* Unanticipated changes – Expected price will not change. For example, if workers do not expect the increase in price, there will be an increase in output. Lucas model predicts that neither monetary nor fiscal policy can affect the equilibrium level of income in the long run. There might be transitory deviations but they are the result of expectations errors and they last only as long as the errors last which is not very long since households and firms will revise their forecasts. RANDOM WALK OF GDP Transitory fluctuations are caused by shocks to aggregate demand while permanent fluctuations are caused by aggregate supply.
The opposite changes in the same factors that cause a decrease in demand can result in an increase in demand and an increase in prices. The supply curve also shifts based on various parts of the market, though some of these factors are different than those of demand. Input prices, technology, expectations, and the number of sellers all affect the equilibrium price of a product. For example, an increase in supply, and therefore a fall in prices, could be the result of a new implementation of more efficient technology in the production process. A decrease in supply, or a rise in prices, could be caused by an increase in the wages paid to the workers in that firm.
There are two types of Fiscal policy put in place to alter the level of aggregate demand; Expansionary fiscal policy and Contractionary fiscal policy. When an economy is in a recession, expansionary fiscal policy is in order. Typically this type of fiscal policy results in increased government spending and/ or lower taxes. A recession results in a recessionary gap meaning that aggregate demand is at a level lower than it would be in a full employment situation. In order to close this gap, a government will typically increase their spending which will directly increase the aggregate demand curve (since government spending creates demand for goods and services).