Distinguish between price elasticity of demand, cross elasticity of Essay

Distinguish between price elasticity of demand, cross elasticity of demand, income elasticity of demand and price elasticity of - Essay Example Section 1: Explanation of important terms 300 Price elasticity of demand Price elasticity of demand shows the relationship between the changes in the quantity demanded of any specific product with the changes in the price of that specific product. The terminology of price elasticity of demand is generally referred to analyze the sensitivity of the prices of the product (Hanushek, & Quigley, 1980). Price elasticity of demand can be calculated using the following formula: If there is a little change in the prices of the good and this small change can cause a large change in the demand of the product, then such a product is said to be elastic. However if there is a significant change in price level of the product but even this significant change in price level cannot cause a small change in the quantity demand of the product then such a product will be said as price inelastic. Cross elasticity of demand In order to analyze the responsiveness of demand of one product when the price is ch anged for another product then it is called as the cross elasticity of demand. ... The following formula is used to calculate the price elasticity of supply Section II: actions that are to be taken to reduce price fluctuations Price is one of the most important factors that influence the purchasing decision of the consumers. It is also the most important factor that influences the production decision of the producers. Therefore changes in price of commodity can influence both the demand and supply of products. Therefore the role of the government is to offer stability in the prices of commodities so that the overall economy can be stable and more stable decisions are taken. There are number of reasons why price level should be stable and one of the most important reasons is that if the prices are more constant and stable then the producers would be able to plan their production accordingly. As producers plan production at a specific level at a constant price, but if the price changes then it can influence supply. For instance, if the price is increased then it will increase the supply of the commodity as shown in the graph below: As the prices have increased, producers want to increase their production so that they can earn more and sell more products at the higher price. However with increase in price, the demand of the products have reduced and thus it is showing that the consumers are not willing to buy the same amount of commodity at the higher prices. Therefore it is showing that the increase in price has increased the supply but it has decreased the demand. Thus a new equilibrium has been formed at Price level P1 and Quantity Q1. Changes in the price level influence the demand and supply of the goods and therefore it is shown that