Significance of Price Elasticity of Demand-Samples for Students

Questions: 1.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. 2.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: Introduction The study focuses on the significance of price elasticity of demand in the decision making of the entity. The price elasticity of demand signifies the responsiveness of change in quantity demanded of goods or services with respect to alternation in its price. This assignment also highlights on the concepts of comparative advantage and absolute advantage along with the examples of situations in which nations have ignored principles of comparative advantage. The international theories have developed during the past few years with the commercial world being highly integrated after globalization. In this perspective, the two basic trade theories that existed over the decades are Absolute advantage and comparative advantage. 1.Precisely, the price elasticity of demand reflects the measure of degree of sensitivity of quantity demanded of the product owing to variation in price, other factors including consumers income, related product prices etc remaining constant. There are two types of price elasticity such as cross price elasticity and own price elasticity. Cross price elasticity are vital for understanding the exchange rate of products as this determines the fluctuation in quantity demanded of a commodity due to change in price of other product involved in production (Bauer, 2014). While, own price elasticity determines the price of a product when there is a change in its quantity demanded. The firms use the price elasticity of demand for each product for making the pricing strategies that is usually explained with the concept of price discrimination. Price discrimination phenomenon refers to the pricing strategy that usually occurs in the monopoly market structure, in which the retailers charge various prices for same products to the customers (Baumol Blinder, 2015). This mainly depends on the relative price elasticities of demand as well as variation in demand in the sub-market. Graph 1: Price discrimination The figure below highlights that, as the demand elasticity of product differs between the markets, the manufactures might charge higher price in the market in which the demand is highly inelastic, which in turn increases profit. 2.The Absolute advantage theory was proposed by Adam Smith in the international trade. According to Absolute advantage theory, the nations must produce as well as export those products, in which they gains absolute advantage in manufacturing (Schumacher, 2012). This means that the nations will produce those goods in which the resources are efficiently utilized for production. There are many cases which reflects that the two nations being the trading partner, one nation might have absolute advantage in the products over the other. In such situation, the comparative advantage theory fills the gap of previous trade theory. The comparative advantage proposed by David Ricardo defines that the nation might produce as well as export those goods in which it manufactures at less opportunity cost than other nations (Laursen, 2015). Moreover, there are various nations where despite having comparative advantages in few industry might not utilize it. For example, China having enormous comparative advantage in labor intensive goods, does not use them and hence exports capital intensive goods. Conclusion From the above assignment, it can be seen that the comparative advantage theory has been considered as one of the integrating as well as inclusive trade theories. In addition, few nations despite having comparative advantage do not use it in several circumstances. Furthermore, the above study also shows that price elasticity of demand has been considered as one of decisive factors of companies for making pricing strategies. Thus, appropriate utilization of this economic concept might facilitate the companies in maximizing the profit margin. References Bauer, M. J. R. (2014). Principles of microeconomics. Baumol, W. J., Blinder, A. S. (2015).Microeconomics: Principles and policy. Cengage Learning. Laursen, K. (2015). Revealed comparative advantage and the alternatives as measures of international specialization.Eurasian Business Review,5(1), 99-115. Schumacher, R. (2012). Adam Smith's theory of absolute advantage and the use of doxography in the history of economics.Erasmus Journal for Philosophy and Economics,5(2), 54-80.