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Question:

What is the Price Elasticity of Demand ?
 
 

Answer :

Introduction

A model can be defined as a framework that allows an easier explanation of complex economic processes. While the models may be true, others are false. The difference between the two is explained by certain conditions that has to be fulfilled for a model to be termed as positive. According to Ouliaris (2017), the job of the modern economy of the allocation of limited resources and the distribution of output to many agents makes it a complex machine. The agents include the government, individuals and firms. The action of any of the agents have an influence on the others either directly or indirectly. He noted that economists of today build models that acts as roadmaps to reality that helps in the understanding of the operations of the modern economy.

The statement about the economic models being false is not accurate. The government should therefore continue using them for future predictions. The argument is that, predictions through economic models have been in most cases be positive. They help in simplifying the interpretation of various economic predictions. Measurable signals are emitted by economies in their allocation of goods and services which is an indicator of drive to complexity. For instance, the growth of output has been used as an explanation for the growth of an economy which is true since it’s as a result of improved investment level and increased level of employment. The models of inflation shows that it has a negative relationship with the unemployment rate; this has empirically been tested to be true. Formal explanations are invited in the case of empirical regularities given that the economy is complex. Models are important for prediction as they give the theory’s implications and infer the consequences of making various assumptions Odekon (2006).

The inner working of the economy could be understood better if the economists and the policy makers learnt more on the various processes that result in various stylized facts. The economy could be directed towards achieving a more desirable outcome when such knowledge is applied in the future predictions. This may include issues like the avoidance of a global financial crisis. Bearing the fact that economic outcomes lack objective measures, economic models are made subjective in design which acts as a very important feature. The forms taken by economic models according to Dwivedi (2006) are either – mathematical equations, graphs or logical statements. Odekon affirms that business firms, individuals and governments need economic prediction in the planning of their future course; this is facilitated by applying various models.

Economic models are divided into two broad categories – the theoretical and empirical models. The theoretical models analyses economic behaviors and derives verifiable implications with an assumption of objectives maximization given various constraints clearly explained in the model. The answers provided by the theoretical models to specific questions are qualitative such as ways of handling market failures. The aim of the empirical models in contrast is to verify the theoretical models’ qualitative predictions by converting them to precise numerical outcomes. For instance, when considering the behavior of an agent’s consumption, the theoretical model indication that the expenditure is positively related to the agent’s income. On the other hand, the empirical models does a deeper analysis and tells us facts like the extent by which expenditure changes when income rises by specified units. According to Carr-Hill & Stern (1977), the relevancy of economic models is raised by the fact that they allows for additional of new variables which improves the accuracy of results.

 


Economic behavior theory is described by an economic model through a mathematical equation set. Useful clues about the behavior of rational agents or rather the working of the economy is derived from the inclusion of many equations in the economic model. The economic models could either be simple or rather complex. A simple model is for example when you consider how the demand for a specific product is influenced by its price. The higher the price of that product, the lower its demand and vice versa. The complex models include for example the prediction of an economy’s real level of output. Lipsey & Chrystal (2011) noted that a model is accurate since it is developed from real economic observations. The economic models are useful in the real world if they are based of accurate assumptions Dwivedi (2010). He also noted that the behaviors of agents tend to be similar which improve the accuracy of an economic model.

 

Source: https://spot.colorado.edu/~kaplan/econ2010/section4/section4-main.html

The figure above shows that products such as gasoline have a low price elasticity of demand. A rise in the price of gasoline from $1 to $1.10, is a 10% increase. The resulting fall in the quantity demand is very little; from 20 to 19 gallons, it’s a 5% decrease. The result of dividing the % change in quantity demanded and the % change in price is 0.5. This is observed in the short run. In 2016, the PED for gasoline was -0.26 (Moffatt, 2016). This is a small magnitude of responsiveness.

 

Source: https://spot.colorado.edu/~kaplan/econ2010/section4/section4-main.html

The figure above shows that products such as sodas have an elastic price elasticity of demand. A rise in the price of six-pack sodas from $2 to $2.20, is a 10% increase. The resulting fall in the quantity demand is very little; from 1000 to 850 gallons, it’s a 15% decrease. The result of dividing the % change in quantity demanded and the % change in price is 1.5. The PED for a six-pack soda is relatively elastic (Kaplan, 2002). In 2015, the PED for soft drinks was −1.06 and that for sugar-sweetened beverages was −1.16 (Colchero, et al., 2015). This is a greater magnitude. In 2016, the PED for apples was -0.58 (usda.gov, 2016). This is a small magnitude owing to the fact that the substitutes to fruits are so many.

 

References

Carr-Hill, R. & Stern, N. (1977). Theory and Estimation in Models of Crime and its Social Control and their Relations to Concepts of Social Output.

Colchero, M., Salgado, J., Unar-Munguia, M., Hernerndez-Avila, M., & Rivera-Dommarco, J. (2015). Price elasticity of the demand for sugar sweetened beverages and soft drinks in Mexico. Sciencedirect.com. Retrieved 15 March 2017, from https://www.sciencedirect.com/science/article/pii/S1570677X15000611

Dwivedi, D. (2006). Microeconomics: Theory and applications. New Delhi: Pearson Education.

Dwivedi, D. (2010). Macroeconomics: Theory and policy. New Delhi: Tata McGraw Hill Education Pte Ltd.

Kaplan, J. (2002). Principles of Microeconomics: Section 4 Main. Spot.colorado.edu. Retrieved 15 March 2017, from https://spot.colorado.edu/~kaplan/econ2010/section4/section4-main.html

Moffatt, M. (2017). Would a Gasoline Tax Cause People to Buy Less Gas?. ThoughtCo. Retrieved 15 March 2017, from https://www.thoughtco.com/price-elasticity-of-demand-for-gasoline-1147841

Lipsey, R. & Chrystal, K. (2011). Economics. Oxford: Oxford University Press.

Ouliaris, S. (2017). Economic Models: Simulations of Reality. Imf.org. Retrieved 14 March 2017, from https://www.imf.org/external/pubs/ft/fandd/basics/models.htm

Odekon, M. (2006). Encyclopedia of world poverty. Thousand Oaks, Calif: SAGE Publications.

usda.gov. (2016). USDA ERS - Food Demand Analysis. Ers.usda.gov. Retrieved 15 March 2017, from https://www.ers.usda.gov/topics/food-choices-health/food-consumption-demand/food-demand-analysis/

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