Microeconomics and Market Systems pt 2

Sir Shannon Scott Williams



Microeconomics



Unit 2: Individual Project

Microeconomics and Market Systems


American InterContential University, Online
Professor Ramin Maysami, Ph.D., CFP.


January 15th, 2011

Abstract:

            In every economy, prices tend to change due to the scarcity of resources.  A season changes from autumn to winter, and consumers are likely to have less demand for autumn clothing and increased demand for winter clothing.  This example is just one factor for the price elasticity of demand.  To prepare for changing prices, economists use this tool to understand how it will affect gains, or losses, on revenue.  For certain products, if the price increases too much, consumers may lose interest and consider another product.  Other products may not have a change at all due to the great demand.  This paper will give a scenario on the change in price and demand, and how to understand the calculations to what equals the price elasticity of demand.  Once understood, readers will be able to determine the elasticity of the product.

            In the given scenario, you own a business painting a developmental neighborhood.  There are several houses to be painted and you have a high demand for paint.  The current rate per gallon for paint is $3.00 a gallon in which you normally purchase 35 gallons.  Over a period of time, your painting business does great, and then price increases to $3.50 per gallon.  Due to that change you are now purchasing 20 gallons of paint.  To understand the elasticity of this product, you will be shown how to calculate the price elasticity of demand, change in price percentage, and change in quantity demanded, (Krugan, Wells, 2009, p. 144-145).

Equation for price elasticity of demand equals:
(Percentage change in quantity demanded / Percentage change in price)
In order to calculate price elasticity of demand we must first determine percentage change in quantity demanded and also percentage change in price.
Percentage (%) change in quantity demanded equals:
            [(New quantity – Old quantity) / Old quantity] x 100 = % Change in quantity demanded
To calculate your percentage change in quantity demand, take the new quantity demanded, 20 gallons of paint, minus the old quantity demanded, 35 gallons of paint, and then divided that by the old quantity demanded, 35 gallons of paint, and finally multiply by 100.
            [(20 – 35) / 35] x 100 = (-3/7) x 100 = -0.42 x 100 = |-42%| = 42%
The result is a negative percentage due to the demand in paint decreased, but report the percentage as an absolute value.
Next calculate the percentage change in price.
Percentage (%) change in price equals:
            [(New price – Old price) / Old price] x 100 = % Change in price
To calculate our percentage change in price, take the new price, $3.50 per gallon of paint, minus the old price, $3 per gallon of paint, and then divided that by the old price, $3 per gallon of paint, finally multiply by 100.
            [($3.50 - $3) / $3] x 100 = (1/6) x 100 = 0.166 x 100 = 16 %
Input those percentage changes to the price elasticity of demand, (percentage change in quantity demanded / percentage change in price).
Price elasticity of demand equals:
            42% Quantity demanded change / 16% Price change = 2.62

            As you can see from the calculations for price elasticity of demand, 2.62, this product would be considered elastic, when the price elasticity of demand is greater than one, (Krugan, Wells, 2009, p. 149). It is logical that you would buy less paint due to the price increase.  This price increase affects your business expenses.  Suppose you accepted the price change at $3.50, and bought 30 gallons of paint, you would almost have the same amount of paint, short 5 gallons.  However if the price per gallon decreased the next month to $2.50, you could have saved money from your expenses if you instead bought 20 gallons of paint.  Clearly, when prices change, consumers should be cautious because the price could change again.
References:
            Krugan, Wells. (2009). Economics (2nd Ed.).
            Worth Publishers. AIU Online Version

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