Perfect Inelasticity & Elasticity of Demand-Samples for Students

Questions: Explain the concept of the Price Elasticity of Demand and Provide examples where understanding the nature of the Price Elasticity of Demand has been important in the decision making of a firm. Explain the Concepts of Comparative advantage and absolute advantage and provide examples of situations in which countries have ignored the principle of comparative advantage to their cost. Answers: 1.Price elasticity of demand: Price elasticity of demand captures degree of responsiveness of the consumers in terms of quantity demanded. It makes reflection of the intensity and direction regarding the change sin demand for unit change in price. Elasticity helps to capture the direction as well as intensity of variation in quantity demanded for one unit rise or fall in price. It is defined as: Perfect inelasticity and elasticity of demand are two extreme cases of captured by E=0 and E=Based on the values of E, types of elasticity can be explained. For E1, it explains that one unit change in price there would cause than one unit change in demand (Rios, McConnell Brue, 2013). This is called price inelasticity of demand. E=0, implies perfectly inelastic. E1 refers to elastic demand referring to more than unit change in demand for one unit change in price (Hall Lieberman, 2012). Suppose Nokia wants to launch a new phone with higher price than before then the elasticity of demand needs to be incorporated by the firm in his strategy planning. Generally, high priced gadgets fall in luxurious good category capturing elastic demand that reduces demanded quantity substantially for increase in price. This is not good for the profit incentive of the business. 2.Absolute comparative advantage: It is one of the leading concepts underlying the international trade among nations. A nation is defined to have absolute advantage if it has lower labor requirement in per unit production. This further reflects the labor productivity applied in production. Labor being the only input in production, higher productive labor consolidates the absolute advantage of the nation compelling it to specialize in line of production with the goods that yields more output per unit of labor (Feenstra, 2015). Labor hour per unit of production Country Food Wine A 20 30 B 40 15 Figure 1: Absolute Advantage Country A seems to require lesser unit of labor in production of food and Country B has little labor requirement in production wine. The doctrine of absolute advantage would suggest A to produce food and trade it for wine with B. Figure 2: Graph Showing Absolute Advantage In the theory of international trade economics concept of comparative advantage indicates the ability a nation has to produce a good comparatively at lower opportunity cost as well marginal cost. Opportunity cost is the driving factor behind the concept of comparative advantage and refers to the amount of some production to be undergone in order to conduct production in one particular sector (Laursen, 2015). This consolidates how trade is beneficial for both the nation creating value and allowing nation to produce the good that has lower opportunity cost and fewer use of resources. Opportunity Cost of per unit production Country Food Wine A = 2/3 unit of wine (1) = 3/2 unit of food (1) B = 8/3 unit if wine ( 1) 3/8 unit of food (1) Figure 3; Opportunity Cost Comparative Advantages Based on the labor requirement of per unit production stated in table 1Country A has lower opportunity cost of food production in terms of foregone wine compared to wine production in terms of food production in which B has comparative advantage. Hence All specialize in food production and Bi in wine production and they will trade with one another the goods in order to create value and benefit out of it. References: Feenstra, R. C. (2015).Advanced international trade: theory and evidence. Princeton university press. Hall, R. E., Lieberman, M. (2012).Microeconomics: Principles and applications. Cengage Learning. Laursen, K. (2015). Revealed comparative advantage and the alternatives as measures of international specialization.Eurasian Business Review,5(1), 99-115. Rios, M. C., McConnell, C. R., Brue, S. L. (2013). Economics: Principles, problems, and policies. McGraw-Hill.