Question

Suppose the price elasticity of demand for stocks is 1.5. This means that for every 10 percent increase in stock prices, the quantity demanded will decline by 15 percent. Does this price clasticity make sense? Explain.

Short answer

Short Answer: Yes, the price elasticity of demand for stocks being 1.5 makes sense, as it indicates that stocks are considered more like luxury goods by investors, who are sensitive to price changes and adjust their demand accordingly. As stock prices increase by 10%, the quantity demanded decreases by 15%, demonstrating an inverse relationship between price and quantity demanded.

Step-by-step solution

Understand Price Elasticity of Demand

Price elasticity of demand is a measure of how responsive the quantity demanded of a good is to a change in its price. It is calculated by dividing the percentage change in quantity demanded by the percentage change in price. In this case, the price elasticity of demand for stocks is 1.5.

Apply the given price elasticity value

We are given that for every 10 percent increase in stock prices, the quantity demanded will decline by 15 percent. We can represent this mathematically as follows: Percentage change in quantity demanded = -1.5 * (Percentage change in price) Our percentage change in price is given as 10%, so now we can calculate the percentage change in quantity demanded: Percentage change in quantity demanded = -1.5 * (10%) Percentage change in quantity demanded = -15%

Interpret the result

The result indicates that as stock prices increase by 10%, the quantity demanded decreases by 15%. In this context, it is important to consider that stocks are generally considered normal goods, with a positive relationship between price and quantity demanded. However, this result shows an inverse relationship, which implies that stocks are more like luxury goods, which are more sensitive to price changes.

Determine if the price elasticity makes sense

Given the nature of stocks, this price elasticity of demand does make sense, as stocks could be considered luxury goods. Investors are usually more sensitive to stock prices changes and are more likely to reduce their quantity demanded when prices go up. In conclusion, a price elasticity of demand of 1.5 for stocks does make sense because the negative relationship between price and quantity demanded indicates that stocks are considered more like luxury goods by investors. They are more sensitive to price changes and adjust their demand accordingly.

Key concepts

Stock Market Economics

Stock market economics is a branch of financial economics that studies how stock prices are determined and how they fluctuate in response to various factors. It encompasses the analysis of supply and demand for stocks, as well as the broader economic influences that can impact the stock market, such as interest rates, company earnings, and global events. The stock market reflects the collective actions of all its participants, from individual investors to large institutions, and understanding their behavior is crucial for grasping why stock prices change. In our context, the price elasticity of demand for stocks reveals the sensitivity of investors' demand to price changes. High elasticity indicates that investors are quick to buy or sell as prices fluctuate, making stock markets highly reactive to news, trends, and economic indicators.

When the price of stocks increase, some investors may perceive them as overvalued, or they may expect future prices to fall, and consequently, they sell their stocks. Conversely, falling prices might attract those looking for a bargain, leading to an increase in quantity demanded. This dynamic is a fundamental aspect of stock market economics, playing a critical role in investment strategies and market predictions.

Elasticity of Goods

The concept of elasticity, in economic terms, measures how much the quantity demanded of a good reacts to a change in its price. Elasticity of goods can vary greatly, depending on the nature of the goods in question. Necessities tend to have inelastic demand because consumers will purchase them regardless of price changes, while luxuries often have elastic demand since their consumption may be significantly altered by price changes.

For instance, medications can often be inelastic because they are essential for health regardless of cost, whereas demand for luxury cars is more elastic because consumers may delay purchase or choose different models based on price fluctuations. These concepts are particularly important for businesses and policy makers, who must understand how price changes can impact consumer behavior and thereby affect the overall market.

Percentage Change in Quantity Demanded

The percentage change in quantity demanded is a crucial measure in economics that indicates how much the quantity demanded of a product or service changes in response to a price variation. It's calculated by taking the difference between the new and original quantity demanded, divided by the original quantity demanded, and then multiplying by 100 to get a percentage. For a good with high price sensitivity (elastic), a slight change in price might lead to a significant change in the quantity demanded—an essential insight for businesses adjusting prices or for investors understanding market reactions.

For example, if the original quantity demanded of a product was 100 units and it drops to 85 units after a price increase, the percentage change in quantity demanded would be \( \frac{85 - 100}{100} \times 100 = -15\% \). This calculation provides a straightforward way of analyzing consumer behavior and market trends.

Percentage Change in Price

The percentage change in price refers to the degree to which the price of a good or service changes over a certain period, typically expressed as a percentage. To calculate it, we subtract the original price from the new price, divide by the original price, and then multiply by 100. This figure helps individuals and businesses to understand inflationary trends, the competitiveness of the market, and the potential impact of pricing strategies on demand.

For example, if the price of a commodity increases from \(10 to \)11, the percentage change in price is \( \frac{11 - 10}{10} \times 100 = 10\% \). This type of calculation is essential for creating pricing strategies, as different levels of price changes can have varied impacts on consumer demand, depending on the price elasticity of the product.