Concept of Price Elasticity of Demand

Question: Discuss about the Concept of Price Elasticity of Demand. Answer: The objective of this interview is to introduce and apply the concept of price elasticity of demand to analyse the differences in prices and quantity consumed of selected goods in India and Canada. The interview primarily focused on bringing out differences in transportation and consumption of rice and hence understanding the relation between price and quantity in the two geographies based on the respective responses. The information collected during the interview coupled with some external research has enabled to opine on the relative differences in the elasticity. The various questions asked in the interview are as follows. What was the transportation option that was most frequently used in your native country (India) as compared to the current scenario? One of the food items that were consumed in abundance by my partner was rice. How does the current situation differ in terms of consumption of rice and whether now you consume more and less? Also comment on the price difference of rice taking India and Canada. What differences in behaviour have you brought about due to the above? Based on the responses, it was apparent that while in India, the most often used transportation option in the city which my partner resided happened to be Metro rail. The reason of frequent use was on account of it being the cheapest mode of communication and also saving on the precious time wasted due to congestions. This was contradictory to private cars being the frequently used means as public transport tends to be inconvenient and time consuming. With regards to rice, the consumption of rice is lower in the current situation as compared to back home. This is primarily on account of higher price in Canada as compared to India. As a result, there is a search for substitutes particularly in the form of wheat flour coupled with higher intake of chicken. Besides, in the long term, my partner aims to have a personal car so as to avoid usage of public transport which is inefficient. Computation of Elasticity Mode of Communication The preferred communication medium used by my partner is Delhi metro. The last price hike was in 2012. Price per trip paid by my partner before increase = INR 20 Price per trip paid by my partner after increase = INR 28 Monthly trips at price per trip of 20 = 25 Monthly trips at price per trip of 28 = 23 % change in price = [(28-20)/20]*100 = 40% % change in demand = [(23-25)/25]*100 = -8% Hence, price elasticity of demand (PED) of metro service = -8/40 = -0.2 As the PED is significantly smaller than 1, it is apparent that the demand for metro services for my partner was highly inelastic (Nicholson and Snyder, 2011). Some of the potential explanations for the same are offered below (Mankiw, 2014). There are almost no cheaper alternatives available as the other means of transport are more expensive and comparatively are not as convenient as the metro journey. Besides, there is the problem of congestion on roads which makes the other modes less preferable and more harrowing. Additionally, the amount spent on metro services by my partner in a month is not very significant which further adds to a low elasticity as due to the price increase, he ends up paying about INR 400 more or less then $ 10. The above analysis would be in sharp contrast to public transport here as it is expected to be comparatively more elastic as people have low preference for the same and hence price increase would further dampen the demand (Campbell, 2011). Based on the inputs from my partner, the objective is to compute the PED of rice. Price of basmati rice in India = INR 60 per kg Price of basmati rice in Canada (Walmart) = $ 3 per kg = INR 150 per kg (Assuming a conversion rate of $ 1 = INR 50) Monthly consumption of rice in India = 12 kg Monthly consumption of rice in Canada = 5 kg Percentage change in price of rice = [(150-60)/60]*100 = 150% Percentage change in quantity demanded of rice = [(5-12)/12}*100 = - 58.3% Hence, PED of rice = -58.3/150 = 0.39 From the above, it is apparent that demand of rice for my partner is inelastic since PED is lower than 1 (Krugman and Wells, 2013). Some of the reasons attributed to inelasticity of rice are as follows (Pindyck and Rubinfeld, 2011). Food preferences are typically developed over a long period of time and hence changing them over the short period of time may be difficult. Additionally, rice is considered to be a staple food and hence adds to the inelasticity. However, availability of other food items particularly wheat at a lower price helps in increasing the PED. The fact that the total monthly spending on rice is only a small fraction of the budget also leads to the lower value of the PED. The long term implications of the above two are as follows. Considering that the public transport system in Canada is inefficient, hence it is convenient and recommended for saving time that personal car be brought especially when working. Further, the cheap prices of cars, fuel and flexible financing option also make cars a lucrative option. In terms of food preferences, over the long run, it is expected that food habits would show some inclination towards the articles which are cheaper and gradually their consumption would increase. Conclusion From the above analysis, it is fair to conclude that price elasticity of demand is a very useful concept with regards to developing an understanding of consumption choices. Besides, the price elasticity of demand tends to highly variable for products and essentially is driven by the nature of product (basic or luxury) and the availability of cheaper substitutes coupled with contribution to the overall budget. For both the products analysed above, considering that these are basic goods with limited availability of cheaper alternatives and low contribution to the budget, the PED essentially remains low on expected lines. References Campbell, W. (2011), Public Transit Viewed As 'Inconvenient', 12% Of Canadians Use It: StatsCan, Retrieved on December 6, 2016 from https://www.huffingtonpost.ca/2011/08/24/public-transit-viewed-as-_n_934998.html Krugman, P. and Wells, R. (2013), Microeconomics, London: Worth Publishers Mankiw, G. (2014), Microeconomics, London: Worth Publishers Nicholson, W. and Snyder, C. (2011), Fundamentals of Microeconomics, New York: Cengage Learning Pindyck, R. and Rubinfeld, D. 2011, Microeconomics, London: Prentice-Hall Publications