Solution :

Determinants of Price Elasticity of Demand :

1) Availability of close substitutes :

If consumers can substitute the good for other readily available goods that consumers regard as similar, then the price elasticity of demand would be considered to be elastic. If consumers are unable to substitute a good, the good would experience inelastic demand.

2) If the good is a necessity or a luxury :

The price elasticity of demand is lower if the good is something the consumer needs, such as Insulin. The price elasticity of demand tends to be higher if it is a luxury good.

3) The proportion of income spent on the good :

The price elasticity of demand tends to be low when spending on a good is a small proportion of their available income. Therefore, a change in the price of a good exerts a very little impact on the consumer’s propensity to consume the good. Whereas, when a good represents a large chunk of the consumer’s income, the consumer is said to possess a more elastic demand.

4) Time elapsed since a change in price :

In the long term, consumers are more elastic over longer periods, as over the long term after a price increase of a good, they will find acceptable and less costly substitutes.

How price elasticity can impact pricing decisions :

Elasticity helps us understand how much a change in price will affect market behaviors. If we make a small change in price, will the change have a dramatic impact on the demand for the product or only a small impact? Price elasticity is the measure of the market’s response to price changes.

Elasticity is important to pricing decisions because it helps us understand whether raising prices or lowering prices will enable us to achieve our pricing objectives. Will a discount drive increased sales? Will a price increase cause us to lose many buyers or just a few? We have to answer these questions in order to select the most effective pricing strategy.

How price elasticity can impact Total Revenue of firm :

If demand is elastic at a given price level, then should a company cut its price, the percentage drop in price will result in an even larger percentage increase in the quantity sold—thus raising total revenue. However, if demand is inelastic at the original quantity level, then should the company raise its prices, the percentage increase in price will result in a smaller percentage decrease in the quantity sold—and total revenue will rise.

How price elasticity can impact Consumer or Producer Surplus :

1) When the demand for a good or service is perfectly elastic, consumer surplus is zero because the price that people pay matches exactly what they are willing to pay.

2) In contrast, when demand is perfectly inelastic, consumer surplus is infinite. In this situation, demand does not respond to a price change. Whatever the price, the quantity demanded remains the same. Are there any examples of products that have such zero price elasticity of demand? Perhaps the closest we get is a life-saving product with no obvious substitutes - in this situation, consumers' willingness to pay will be extremely high

3) The majority of demand curves in markets are assumed to be downward sloping. When demand is inelastic (i.e. Ped<1), there is a greater potential consumer surplus because there are some buyers willing to pay a high price to continue consuming the product. Businesses often raise prices when demand is inelastic so that they can turn consumer surplus into producer surplus.

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What are the determinants of price elasticity of demand? Identify at least three examples. explain how price elasticity can impact pricing decisions and total revenue of the firm, can policy market interventions cause consumer or producer surplus

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