ECO501 Business Economics

Explain the concept of the price elasticity of demand and provide examples where understanding the nature of the price elasticity of demand has been important in the decision making of a firm.

Explain the concepts of comparative advantage and absolute advantage and provide examples of situations in which countries have ignored the principle of comparative advantage to their cost.

The price elasticity of demand of a commodity can be defined as the percentage change in the demand of the commodity due to one percent change in the price of the commodity. The assignment tries to discuss the implication and importance of price elasticity of demand in the decision-making perspectives of firms (Rader, 2014).

Analysis

The price elasticity of demand is an economic concept which shows the degree of responsiveness of demand of a commodity with respect to the change in the price of the commodity or the price of the related commodities, which includes substitutes or complements. The former is known as the own price elasticity of demand while the latter is known as the cross price elasticity of demand. The own price elasticity indirectly shows the nature of demand of the customers and how much flexible they are with respect to the changes in prices.

This is immensely important for the purpose of production and pricing decision-makings of the firms in the economy. One of such cases is the practice of price discrimination by the firms, especially by the monopolistic firms. Price discrimination is the economic practice in which the same seller charges different prices for the same commodity in different markets, which have different elasticity of demand (Ekelund Jr & Hébert, 2013).                                                                          Price Discrimination

As can be seen from the above figure, in this scenario, price elasticity of demand in the first market is less than that in the second market. Taking advantage of this situation the sellers can charge more in the first market than in the second market which helps in increasing their revenue and profit.

Conclusion

Thus, from the above discussion it can be asserted that the price elasticity of demand is of immense importance for the firms for designing their pricing strategies to increase their profitability.

International trade has undergone significant dynamics over the years and the trade theories have also evolved significantly with time and requirements of international trade. In this context, the assignment takes into consideration the trade theories of absolute advantages and comparative advantages in production and trade.

Analysis

The theory of absolute advantage, as first proposed by Adam Smith, states that the countries should export and produce only those commodities or services in which they experience absolute advantage of production over their other trading partners. Thus, the countries should concentrate on producing and trading those commodities, which they can produce more using the same amount of resources as the other countries and trade them for those commodities in which they do not enjoy the same (Johns, 2013).

However, in many instances it happens that among two trading countries, one country enjoys absolute advantages in production of all the commodities while the other does not enjoy the same in any commodity. Trade, then becomes non-feasible according to this theory.

Considering such cases, David Ricardo proposed the theory of Comparative Advantage, according to which the countries should produce and export those commodities or services in which the opportunity cost is lesser than the other countries (Cuñat & Melitz, 2012). However, both the absolute as well as comparative advantage theories indicate towards the importance of specialization in the economy.

However, there are several instances in which, several countries, in spite of having comparative advantages of production and trade in some commodity or services do not use the same. Japan is one such example. Japan enjoys immense comparative advantages in technical commodities. However, it believe in protectionism and believes it to be one of the contributing factors in its success and therefore, does not utilize its comparative advantages.

Conclusion 

From the above discussion, it can be concluded that though there are feasibility of trade theories like those of absolute and comparative advantage theories, however, there are several instances in which the countries do not utilize these advantages in trade in spite of having the same.

References 

Cuñat, A., & Melitz, M. J. (2012). Volatility, labor market flexibility, and the pattern of comparative advantage. Journal of the European Economic Association, 10(2), 225-254.

Ekelund Jr, R. B., & Hébert, R. F. (2013). A history of economic theory and method. Waveland Press.

Johns, R. A. (2013). International trade theories and the evolving international economy. Bloomsbury Publishing.

Rader, T. (2014). Theory of microeconomics. Academic Press