Factors influencing price elasticity of demand

1. In economics, demand and supply use as a basic tool to determine the market price of a product. Demand concept also influences by the concept of elasticity (Coglianese, Davis, Kilian & Stock, 2017). With the help of this concept, a firm can understand that whether it can charge comparatively higher price or not. Comparative advantage on the side helps a company to export and import products based on this theory.

The price elasticity for demand measures the degree of responsiveness regarding quantity demanded for a particular product when own price of it changes significantly. The value of own price elasticity for demand gives negative outcome to indicate opposite relation. The value of price elasticity can be obtained as a ratio between percent changes in quantity with percentage change in price (Olmstead et al., 2015). When the determined value remains more than 1, it implies elastic demand curve. On the others side, when the value of this elasticity becomes less than one then it implies an inelastic demand curve. To determine price elasticity of demand, three factors play significant role. These factors are availability of substitutes, time and necessity, which can be precisely as follows:

Availability of substitutes: When a product has more substitutes available in market, the demand for it becomes more elastic. In this situation, a small increase in price can lead people to purchase the substitute product. Therefore, demand in this situation will reduce considerable due to a small increment of price (Burke & Abayasekara, 2018). On the contrary, if the product does not have any substitutes, then the demand for this product will not change by large extend due to change in price. For instance, if the price of one cup coffee increases by E$0.25, consumers may shift their preference towards tea. This implies that the demand for coffee is elastic.

Time: This can influence demand elasticity of a product significantly. Within a particular time period, a person can obtain limited substitute products (Labandeira, Labeaga & López-Otero, 2017). In this situation, the demand for this particular product does not change significantly and consequently inelastic demand can be observed. On the other side, the opposite situation can be raised when time period increases significantly.

Proportion of income spent on the good: If consumers spend comparatively less portion of their income to purchase the product then the demand will be inelastic. This can occur for inferior products.

Nature of commodities: For a necessary product, the demand does not fall by large extend due to price change. In this situation, the demand for this product becomes inelastic. This situation can be observed for life saving medicines. For instance, people use petroleum to go from one place to another within short-period (Conrad, Jahns & Roemmich, 2018). Therefore, increase in price of this fuel may not reduce its demand. Per capita incomes in developing countries remain low and this in turn force these people to purchase only necessary products such as milk, cloth and wheat and so on (Hubbard, Garnett & Lewis, 2012). To sustain, people need to buy these products without considering their prices. In this situation, demand for those basic commodities becomes inelastic.

Case study: Uber

Joint demand: If demand for two products have close link then demand for one product can be changed significantly due to change of other product. Therefore, elasticity of demand depends significantly with the demand of other product.

The switching cost between two products: To switch between two products, a consumer may need to bear some certain costs. In this situation, demand for this product could be inelastic. For instance, mobile phone service providers may provide a scheme of 12 months so that consumers cannot move to other company.

                                                             Figure 1: Elastic demand curve

The above figure represents elastic demand curve with a comparatively flatter slope.  From the above figure, it can be seen that when price increases from P2 to P1, demand for the product reduces from Q2 to Q1. Moreover, the amount of price increase is low compare to the amount of quantity demanded.

                                                                  Figure 2: Inelastic demand curve

The above figure represents inelastic demand curve with a steeper demand curve. In this figure price increases from P1 to P2 while quantity demanded decreases from Q1 to Q2. In this inelastic demand curve, the magnitude of change in price is large compare to change in quantity demanded.

The price elasticity of demand can be described with the help of a case study. Uber has become the fastest growing company that provides taxi service across the world. In 2015, the venture-capital firms value this taxi company at about USD41 billion. Uber applies dynamic pricing strategies, which means different prices will be charged in different times.  Therefore, during the peak times, demand for Uber taxis become less elastic compare to other times (Oladosu et al., 2018).). This happens due to lack of substitute product. Therefore, the company can earn comparatively higher revenue during peak session. However, economists have criticized this pricing strategy, as it charges higher prices during emergency period.

Conclusion:

Therefore, from the above discussion it can be observed that price elasticity chiefly depend upon various factors. Availability of substitute products, time and types of the product has significant impact on the magnitude of the demand. This situation has been described precisely with the help the Uber case study.  

2. To protect the manufacturing sector and related job markets, President Trump has taken some protectionist policies. The president has imposed a 25% tariff on steel along with 10 percent tariff on aluminum. Moreover, the US government has composed 25 percent duty on Chinese imports worth $34 billion on 6^th July, 2018. At the same time, China also responds through imposing 25 percent tariffs on agricultural products along with cars of the US (Dian, 2018). These policies do not influence Australian economy directly. However, this section of the paper intends to identify that whether Australian economy has been influenced through this policy or not. This can be discussed briefly with the help of comparative advantage theory.

President Trump’s protectionist policies and the Australian economy

The theory of comparative advantage discusses about the ability of an economy to produce as well as services with comparatively lower opportunity cost compare to other countries (Bahar & Rapoport, 2018). During the short-run, Australia will not experience significant impact from these policies. This is because the US does not take any trade policies against this country. As a result, Australia has exempted from this protectionism. One of the chief reasons of this protectionism is that the US enjoys a trade surplus with Australia. Moreover, most of the products are traded between these two countries under the agreement of free trade (Schweller, 2018). From here it can be said that both countries have comparative advantage to trade with each other and for this no trade between them is generated. In addition to this, Australia could enjoy comparative advantage due to the trade war between the US and China. China intends to impose tariff on agricultural products of the US, such as wines, soybeans and meats. Australia also has advantage to produce and enjoy these products efficiently. Therefore, due to trade war, China could import agricultural products from Australia. In addition to this, the country could enjoy more comparative advantage to trade with the US. For Australia, export sectors could earn positive impacts compare to other countries such as Mexico and China. Initially, steel industry in Australia has experienced serious concerns due this protectionism policy (Siskos & Darvidov, 2018). However, the president has stated that exports of defense alliance are not protected significantly. As a result, steel and aluminum exports of Australia exempt and this further generates a longstanding trade relationship of this country with the US.  

However, the impact of trade policy of the US president on Australia could be uncertain during the long term. The entire impact is chiefly depends upon the approach of current protectionism. Focusing on the short-run outcomes related to trade of these two countries the president could decide that whether any long-term policy will be implemented or not to restrict this trading relationship (Corden & Garnaut, 2018). In addition to this, Business of Australia can take this exemption positively with more confidence. This in turn can influence the country’s relationship with global business based on tariffs (Edwards, 2018). As a result, Australian businesses that supply goods and services to US that are exempted from the US trade policies could take further initiatives to utilize free trade agreements.

Conclusion:

Therefore, it can be concluded that trade policy can effect Australian economy positively. Due to free trade policies, Australia has experienced comparative advantage to export agricultural products along with defense allies in the US. Moreover, the country has also experienced advantage to export products in China, which has imposed trade policies of the US products. Therefore, trade war between the US and China has influenced Australian businesses positively. However, it becomes difficult to understand that whether Australia could be affected due to these protectionism policies or not. Comparative advantage plays significant role for a country to conduct its international trade. When the country obtains advantage in terms of labor productivity, resources or other legal factors, then it can produce the good by large amount compare to other countries and can export these products in international market. This also happens with Australia.

References:

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Oladosu, G. A., Leiby, P. N., Bowman, D. C., Uría-Martínez, R., & Johnson, M. M. (2018). Impacts of oil price shocks on the United States economy: A meta-analysis of the oil price elasticity of GDP for net oil-importing economies. Energy Policy, 115, 523-544.

Olmstead, T. A., Alessi, S. M., Kline, B., Pacula, R. L., & Petry, N. M. (2015). The price elasticity of demand for heroin: matched longitudinal and experimental evidence. Journal of health economics, 41, 59-71.

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