Question

A manufacturer of Beanie Babies hires an economist to study the price elasticity of demand for this product. The economist estimates that the price elasticity of demand coefficient for a range of prices close to the selling price is greater than 1 The relationship between changes in price and quantity demanded for this segment of the demand curve is a. elastic. b. inelastic. c. perfectly elastic. d. perfectly inelastic. e. unitary elastic.

Short answer

The demand for Beanie Babies is elastic, as the price elasticity of demand coefficient for a range of prices close to the selling price is greater than 1. Therefore, the correct answer is a. elastic.

Step-by-step solution

Understanding the Concept of Price Elasticity of Demand

Price elasticity of demand is a measure that shows the sensitivity of the quantity demanded of a good or service to a change in its price. It is calculated using the formula: Price Elasticity of Demand (Ed) = % change in Quantity Demanded / % change in Price

Recognizing the Types of Price Elasticities

Based on the coefficient of the price elasticity of demand (Ed), we can classify the elasticity into five different types: 1. Elastic: when Ed > 1 2. Inelastic: when 0 < Ed < 1 3. Perfectly Elastic: when Ed = ∞ 4. Perfectly Inelastic: when Ed = 0 5. Unitary Elastic: when Ed = 1

Find the Type of Price Elasticity for Beanie Babies

The exercise states that the price elasticity of demand coefficient for a range of prices close to the selling price is greater than 1. This indicates that the demand for Beanie Babies is elastic. So, the correct answer is: a. elastic.

Key concepts

Economic Elasticity

Economic elasticity measures the sensitivity of one variable to changes in another variable. Price elasticity of demand, which was used in the original exercise, is a specific type of economic elasticity that measures how much the quantity demanded of a product responds to a change in price.

The formula for calculating price elasticity of demand is given by: \[\begin{equation}Ed = \frac{\% \text{ change in Quantity Demanded}}{\% \text{ change in Price}}\end{equation}\]
If the absolute value of the resulting coefficient (Ed) is greater than one, the demand is considered elastic, which implies that consumers are highly sensitive to price changes. On the other hand, if the coefficient is less than one, demand is inelastic, indicating less sensitivity. A coefficient of exactly one indicates unitary elasticity, where the proportional change in quantity demanded is equal to the proportional change in price.

Elastic Demand

Elastic demand is a concept where the quantity demanded of a good or service significantly changes in response to price changes. This situation was highlighted in the exercise with the Beanie Babies, where the price elasticity of demand was greater than 1.

Characteristics of Elastic Demand

• Consumers purchase significantly less of the good when prices increase.
• Consumers buy significantly more when prices decrease.
• Such goods or services often have plenty of substitutes or are not necessities.
• Customers may view these goods as luxury items or are willing to delay the purchase until prices drop.

Businesses with elastic demand products need to carefully consider their pricing strategies, as consumers could easily switch to alternatives if they perceive the product to be too expensive.

Inelastic Demand

In contrast, inelastic demand indicates a weak relationship between price changes and the quantity demanded. Even with a price change, consumers' purchasing behavior remains relatively constant.

Factors Contributing to Inelastic Demand

• Lack of close substitutes for the good.
• The good is a necessity, e.g., basic food items or medication.
• Cost of the good is a small portion of the consumer's budget.
• Consumption habits that are not easily altered.

Goods with inelastic demand give sellers more leeway to increase prices without fearing a significant loss in sales volume, as buyers do not have many alternatives or are unwilling to change their consumption habits.

Consumer Behavior

Consumer behavior is a study of the decision-making processes of customers and how they consume and dispose of goods and services. It encompasses the psychological, social, and economic factors that influence purchasing decisions.

Understanding consumer behavior is crucial for interpreting elasticity. For instance, if a product like Beanie Babies becomes trendy, consumer behavior might shift towards increased purchasing, regardless of price, which could temporarily make the demand appear inelastic. Over time though, as trends fade, demand may become more elastic as consumers become more price-sensitive.

Market Economics

Market economics involves the study of supply and demand in competitive markets and the allocation of resources through the price mechanism. Demand elasticity is a key concept in this field as it directly influences pricing, production, and revenue strategies for businesses.

For example, in the market for Beanie Babies, understanding how demand for the toys responds to price changes can help the manufacturer determine optimal production levels and set prices that maximize profits without alienating consumers. Therefore, the concept of demand elasticity is a critical tool for economic decision-making and strategic planning in market economies.