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Price Elasticity Of Demand In The Market

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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.In determining price producers have to keep in mind a number of things. Price elasticity of demand is one of them. Proportionate change in demand due to a proportionate change in price is known as price elasticity of demand (Carlton & Perloff, 2015).  The expression of price elasticity of demand is given below:

For producer or business, firm knowledge of demand elasticity is important. If the producer is selling a necessary good, then changing price will not have much effect on revenue. This is because demand for necessary good is inelastic in nature. Opposite is the case for luxury products. Here slight change in price affects revenue a lot due to highly elastic nature.  Therefore, pricing decision should be made depending on nature of the product and elastic response of its demand.

If the producer is a monopolist in the market then strategy of price discrimination depends on elasticity of the submarkets. In submarket having high elasticity, the producer sets a low price. While in market segment, having lower elasticity the producer charges a high price (Thomas, Lubinda & Angula, 2015).

In case indirect tax, producers are in a producer to shift the tax burden on buyers. The extents to which the burden can be shifted depend on demand elasticity. In times of inelastic demand, producer can shift a greater tax burden on buyers by setting a high price. This is not possible while demand is elastic.

 


2.Adam Smith proposed the theory of absolute advantage. The theory was framed in a two-country two-commodity model. If a country is able to produce same amount of one commodity as its competitor, but at a low cost then the country is said to have an absolute advantage in that commodity (Costinot et al., 2015). What matters here is absolute production cost. The said country exports the good with absolute advantage and imports the good with higher cost.

Conflict occurs in case where one advanced country has absolute cost advantage over both the goods. Then the theory of comparative advantage came. Here advantageous position in international trade is determined in terms of opportunity cost. What amount of other good a country should sacrifice to produce one good is considered as the opportunity cost of that good. The initial model of comparative advantage is also a two-country, two-commodity model as like absolute advantage. However, unlike absolute advantage opportunity cost is important here.

International trade based on absolute advantage of countries may not be mutually beneficial while specialization based on comparative advantage is always mutually beneficial. Absolute advantage compares productivity of the nation by comparing efficiency. While comparative advantage involves extent of sacrificing commodity that is more important in field of world trade (Feenstra, 2015)

Comparative advantage has a much broader spectrum than absolute advantage. In fact, theory of comparative advantage is the basis of most of the trade theory. In global market, one country may have absolute advantage in all commodities but it is very unlikely to have comparative advantage in all, as comparative advantage is usually reciprocal and unique.

 

References

Carlton, D. W., & Perloff, J. M. (2015). Modern industrial organization. Pearson Higher Ed.

Costinot, A., Donaldson, D., Vogel, J., & Werning, I. (2015). Comparative advantage and optimal trade policy. The Quarterly Journal of Economics, 130(2), 659-702.

Feenstra, R. C. (2015). Advanced international trade: theory and evidence. Princeton university press.

Thomas, B., Lubinda, M., & Angula, M. (2015). Principles of microeconomics.

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