A1. Elasticity of Demand. The law of demand tells us that consumers will buy more of an item when prices decline and less of an item or product when prices increase. How much more or less consumers will buy varies from product to product along with the change in price. When a restaurant increases or decreases their prices, the consumers are very quick to notice and choose to continue to eat at the same restaurant or another restaurant based on a decrease or increase in price (McConnell & Brue, 2009). Firms use the price elasticity of demand to show how a change in price will affect their revenues. Elasticity determines how a change in price affects total revenue for a firm. This determination is accomplished by measuring the percentage change in quantity demanded after the percentage change in the price has occurred. This is a very important measurement because companies also need to know how a consumer will respond to changes in price for their products in demand (Tomlinson, 2011). Consumers or buyers purchase more of an item when the price is reduced and less of an item when the price is increased. Producers must measure the elasticity of demand for their product output pricing so they can know what the buyer’s response is to changes in the market price, and to plan for their competitors or substitutes who may change prices, all things equal, and the effect it will have on the demand of their product relative to the response of buyers (McConnell & Brue, 2009). Buyers do not pay as close attention to price increases of the items used on a daily basis such as toothpaste, when it is only a few cents different, but buyers are very much aware of changes in luxury items such as movie tickets or large purchase items like cars, for example. Elasticity of demand is calculated by percentage change in quantity divided by the percentage change in price of a given product or item. The simplest and most accurate way this is accomplished is by adding the quantities together and dividing in half, then adding the prices together and dividing in half to get a perfect midpoint. The difference of the quantities is divided by the quantity midpoint and the difference of the prices is likewise divided by the price midpoint, after which the results of the quantities and prices are then divided to get the final percentage (Tomlinson, 2011). Economists prefer the midpoint calculation method because it produces the same answer whether the change in the price is increased or decreased.
A2. Cross-Price Elasticity. Cross price elasticity of demand is a measure of how sensitive buyers are to a change in the price of one good and its effect on another good. It is important to businesses and government to measure the substitutability or complementarity response of goods to cross pricing changes among these goods to know the elasticity response and when to lower a price or increase it to control the supply flow and protect total revenue results.
This change will be positive, all things equal, if they are substitute goods. Positive when the goods are substitute being two different brands of the same item, we will use eggs brand A and eggs brand B for our example. If eggs brand A price increases the demand will increase for eggs brand B and buyers will buy a larger quantity of eggs brand B to show the positive sensitivity to price for eggs. The cross price is also positive when the price decreases for eggs brand A, all things equal, or eggs brand B stays the same, then buyers will purchase larger quantities of eggs brand A. We call this the substitution effect (Tomlinson, 2011). Complementary goods have negative cross price elasticity. Complementary goods are products or services that are used together such that when the price of one complement good falls, the demand for the other or complement good increases. We could use for an example Polaroid cameras and Polaroid film for our complement goods. If there is a decrease