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1. ..
Price Elasticity
Types of Elasticity and behavior in the long
term and short term and effect of Government
Policies and Market Failures
Name
[Pick the date]
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2. 1.1 Price Elasticity of Demand:
Price elasticity of demand can be defined as the sensitivity in the decrease of quantity
demanded with a change in the price of the product. (Klein & Bauman, 2010) For example, if
the price increase by 10% and the quantity demanded falls by 30%, we can deduce that the
demand is quite sensitive to the price. However, suppose with the same increase in price, if
the quantity demanded falls by just 5%, we can assume that the demand is not sensitive to the
price. Moreover, if the price increases by 10% and quantity demand too falls by 10%, we can
assume that the demand Is equally sensitive to the price. This sensitivity to the price with
relation to the demand is known as price elasticity. In scenario 1, we say that the demand is
elastic, in scenario 2 the demand is inelastic and in scenario 3 the demand is unit elastic.
Let us consider an example:
Price Demand
$ Elastic Unit Elastic Inelastic
100 500 500 500
110 416.6667 454.545455 476.1905
121 347.2222 413.22314 453.5147
133.1 289.3519 375.6574 431.9188
146.41 241.1265 341.506728 411.3512

3. Now, Total Revenue is the total income generated by selling the products (or)
services. (Klein & Bauman, 2010)
Mathematically, it be represented as TR = P X Q (TR is Total Revenue; P is the price
and Q is the total quantity demanded or sold at the price). (Klein & Bauman, 2010)
Price Demand TOTAL REVENUE
$ Elastic Unit Elastic Inelastic Elastic
Unit
Elastic
Inelastic
100 500 500 500 50000 50000 50000
110 416.6667 454.545455 476.1905 45833.33 50000 52380.95
121 347.2222 413.22314 453.5147 42013.89 50000 54875.28
133.1 289.3519 375.6574 431.9188 38512.73 50000 57488.39
146.41 241.1265 341.506728 411.3512 35303.34 50000 60225.93
In the above case, TR decreases in case of elastic goods, remains the same in the case
of unit elastic goods and increases in the case of inelastic goods.
Hence, from the above example, we can infer that a company producing elastic goods
will see a drop in total revenue with a price hike and hence have no incentive for increasing
prices. However, a company producing inelastic goods will see a steady increase in Total
Revenue and hence have an incentive to increase the price, even though total demand is
falling. In the case of unit elastic goods, the company Total Revenues remain unchanged,
hence they have no major incentive to increase or decrease the price.
0
100
200
300
400
500
600
100 110 121 133.1 146.41
Elastic
Unit Elastic
Inelastic

4. 2. Price Elasticity of Demand in the Short Run and Long Run:
It is generally believed that the demand for a product will remain more inelastic in the
short run. (Pettinger, 2008). This is because people are used to the consumption of a certain
product and switching from the product may take some time. (Pettinger, 2008). Let us
consider the example of Medicines. People who are prescribed medication, especially life
saving drugs will have to buy them even at increased rates. The quantity demanded may fall,
but it is assumed that the fall in demand will be less sensitive than the increase in the price..
This is because they will have to wait to find a similar compound of the prescribed
medication to them at a cheaper rate. The same compound may or may not be immediately
available, and, hence, it would take time for the switch to happen.
In converse, the demand will be highly elastic in the longer run as consumers will
have more time to adjust their buying patterns and search for substitute or similar goods in
the market.
3. Impacts of government and market imperfections (failures) on the price elasticity of
demand and supply?
Government policies and market imperfections or failures can sometime wreak havoc
in the economy. If the government has a policy to protect its domestic producers from
foreign players, it may impose several restrictions on market entry of these foreign
companies. (Economics Online, 2009) It would result in reducing competition in the
economy which would result in only the domestic players producing a certain product. This
would lead to demand being relatively inelastic, even in the long run, as the consumers would
have no choice but to purchase from the domestic producers, which may be quite a few.

5. Similarly, the use of subsidies may result in prices being kept artificially low which
would mean a higher quantum of demand. (Economics Online, 2009) On the other hand, if
the Government decides to impose taxes on certain products. (Economics Online, 2009) For
example Sin Tax on Alcohol and Cigarettes, the demand for these products will
simultaneously fall, making the goods extremely elastic.
The Government may also take some initiative and fix prices of certain products or
even resources such as labour. (Economics Online, 2009)They might impose a price ceiling
or minimum wage policy. (Economics Online, 2009)
This would again result in artificial prices and have an elastic impact on the demand
for goods.
References:
EconomicsOnline.(2009). Governmentfailure.RetrievedfromEconomicsOnline:
http://www.economicsonline.co.uk/Market_failures/Government_failure.html
Klein&Bauman.(2010). Stand-Up Economics:Stand-Up Economicswith Calculas. Stand-Up
Economics.
Pettinger,T.(2008, April 18). Price Elasticity of Demand – Shortand Long Run. Retrievedfrom
EconomicsHelp:http://www.economicshelp.org/blog/435/concepts/price-elasticity-of-
demand-short-and-long-run/