Price Elasticity of Demand

 

Price

 

S1

E1

P2 S0

P1 E2

 

D

 

Q1 Q2 Quantity

 

 

Yes price elasticity can be used to explain the situation in the restaurant. Price elasticity of demand evaluates the response in the quantity of food demand when a change in price has occurred.

 

Price elasticity of demand as the degree of: Proportionate change in quantity demand

Proportionate change in price

 

 

The Restaurant manager has notice that, when the prices of meals are lowered, total revenue rises. Using the diagram above, if price of meals have been before at P2, where the quantity of meals demanded is at Q1 and market equilibrium is at E1 before any changes, and if the prices have decrease from P2 to P1, would have seen the demand increase from Q1 to Q2 and new market equilibrium at E2.

 

The elasticity of demand Ed = Q2-Q1 x 100

(Q1+Q2)/2

P2-P1 x 100

(P1+P2)/2

 

In the case, elastic (E) is greater than 1, where the quantity demand is relatively elastic, that is the change in price has caused even larger change in quantity demand. Ed is equal to infinity that refers to as perfect elastic. The demand curve is horizontal. Therefore the total revenue increase is caused by the greater increase in demand of the restaurant meal, when there is a lowering of the price of these meals.

 

b)

 

Three Factors that determine price elasticity of demand of a product.

 

 

The Availability of substitutes:

If there are possible substitutes of the same product, the greater the elasticity of price would be. It should be noted that the number of substitutes depends on how the definition of product is broadly defines.

 

Degree of necessity or Luxury

Products that are classified as luxury products tend to have greater price elasticity. Products that have some degree of necessity, or form parts of habitual demand of consumer can become necessities to some consumers and would have a greater elasticity.

 

Proportion of the Consumer’s budget to be consumed by the product

Products that consume the greater proportion of the consumer’s budget tend to have a greater elasticity of price.