Distinguish between price elastricity of demand and cross elasticity o...
**Distinguishing Between Price Elasticity of Demand and Cross Elasticity of Demand**
**Price Elasticity of Demand:**
Price elasticity of demand measures the responsiveness of the quantity demanded of a good or service to a change in its price. It is calculated as the percentage change in quantity demanded divided by the percentage change in price. Price elasticity of demand can be classified into three categories:
1. Elastic Demand: When the percentage change in quantity demanded is greater than the percentage change in price, demand is said to be elastic. This means that consumers are highly responsive to changes in price. For example, if the price of a product increases by 10% and the quantity demanded decreases by 20%, the price elasticity of demand would be -2.
2. Inelastic Demand: When the percentage change in quantity demanded is less than the percentage change in price, demand is said to be inelastic. This means that consumers are not very responsive to changes in price. For example, if the price of a product increases by 10% and the quantity demanded decreases by 5%, the price elasticity of demand would be -0.5.
3. Unitary Elastic Demand: When the percentage change in quantity demanded is equal to the percentage change in price, demand is said to be unitary elastic. This means that the percentage change in quantity demanded is exactly proportional to the percentage change in price. For example, if the price of a product increases by 10% and the quantity demanded decreases by 10%, the price elasticity of demand would be -1.
**Cross Elasticity of Demand:**
Cross elasticity of demand measures the responsiveness of the quantity demanded of one good to a change in the price of another good. It is calculated as the percentage change in quantity demanded of one good divided by the percentage change in price of another good. Cross elasticity of demand can be classified into three categories:
1. Substitutes: When the cross elasticity of demand is positive, it indicates that the two goods are substitutes. This means that an increase in the price of one good leads to an increase in the quantity demanded of the other good. For example, if the price of coffee increases and the quantity demanded of tea increases, the cross elasticity of demand between coffee and tea would be positive.
2. Complements: When the cross elasticity of demand is negative, it indicates that the two goods are complements. This means that an increase in the price of one good leads to a decrease in the quantity demanded of the other good. For example, if the price of cars increases and the quantity demanded of petrol decreases, the cross elasticity of demand between cars and petrol would be negative.
3. Independent: When the cross elasticity of demand is zero, it indicates that the two goods are independent. This means that a change in the price of one good does not affect the quantity demanded of the other good. For example, if the price of apples increases and the quantity demanded of oranges remains unchanged, the cross elasticity of demand between apples and oranges would be zero.
**Importance of the Concept of Elasticity of Demand:**
The concept of elasticity of demand is important for several reasons:
1. Pricing Decisions: Understanding the elasticity of demand helps businesses make informed pricing decisions. If demand is elastic, a decrease in price can lead to a significant increase in quantity demanded, resulting in higher revenue. Conversely, if demand is inelastic, a price increase may not lead to a significant decrease in quantity demanded, allowing