Elasticity Of Demand Case Study

Elasticities can be defined as the measure of degree of responsiveness of quantity of goods demanded or supplied to small changes in its determinants (Mankiw and Taylor: 2011: 95). The determinants used to measure elasticities are the price of goods and services, consumer’s income, substitute and compliment goods. There are two types of elasticities, which are elasticity of demand and elasticity of supply. First, this essay it will discuss the factors affecting elasticity of demand for new cars. Next, it will consider elasticity of supply and the economic factors influencing the elasticity of supply for new cars. Finally, it will state the benefits and problems of using elasticities.

Elasticity of demand is divided into three main types, which

Beg and fisher (2001:36) defines income elasticity of demand as the degree of responsiveness of quantity of goods demanded to little changes in the consumers’ income. That is, YED = percentage change in quantity demanded/percentage change in income.

Different economic factors affect the income elasticity of demand for new cars. One factors is the real income of the car buyers relative to car prices (Riley: 2011). New cars can be classified into three main categories, which are normal cars, luxury cars and inferior cars. For inferior cars such as the Volkswagen cars, when real income is rising, that is pay is increasing faster than inflation, people are likely to demand less of them and a fall in income leads to an increase in demand for them (Boundless:2013). They have a negative income elasticity of demand.

Normal new cars have positive income elasticity of demand. An increase in income leads to an increase in demand for them and a fall in income leads to a fall in demand (Gillespie: 2011:71). They are income inelastic. A luxury new car such as Lamborghini, the demand for them is very sensitive income. This means that a small change in income leads to a larger change in demand for them. They are income elastic

The formula used is: percentage change in quantity demand of good X/percentage change in price of good Y. Cross elasticity of demand is applicable to new cars because there are close substitutes as well as complement goods for them.

The use of public transport is a substitute for new cars. Thus an increase in price of public transport would lead to an increase in demand for new cars. This means that the cross elasticity of demand for new cars would be positive (Slogan: 2009:69). However, if people find it more convenient to use public transport due to a reduction in price, then there will be a fall in demand for new cars leading to a negative cross elasticity of demand for new cars.

P1

P2

Another substitute good that would affect the cross elasticity of demand for new cars is secondhand cars. If price of secondhand cars drops and the cost of running it is relatively cheap, people would demand less of new cars. However if it is more expensive to purchase second hand cars and run it the demand for new cars will increase causing a positive cross elasticity of demand (Slogan: