Unit 1 Micro: Revision on Elasticity of Demand (for Rice)

Here is a planned answer to an exam question

“Assess whether the demand for rice is likely to be price elastic or price inelastic”

The command word assess means that some evaluation is needed in your answer to achieve top marks. Remember the importance of clear chains of reasoning and a genuine attempt to apply the concept of price elasticity of demand to rice in different countries

Planned answer

Price elasticity of demand (Ped) measures the responsiveness of demand following a change in its own price. The formula for calculating the co-efficient of elasticity of demand is:

Percentage change in quantity demanded divided by the percentage change in price

If the coefficient of Ped is between 0 and 1, then demand is inelastic. For example a 20% rise in rice prices might cause consumption to fall by only 5% in which case the Ped = -0.25. If Ped > 1, then demand responds more than proportionately to a change in price i.e. demand is elastic.

Many factors can affect the value of price elasticity of demand.

The more close substitutes there are in the market, the more elastic is demand because consumers find it easy to switch. With rice, although there are some substitutes in consumption notably in richer nations, for many people rice is a crucial part of their staple diet and there is deep reluctance to change consumption when prices change. Necessities tend to have an inelastic demand. For many people especially in lower-income countries, rice a necessity which suggests a low price elasticity of demand.

The proportion of a consumer’s income allocated to spending on the good also affects Ped – expensive products that take up a high % of income will tend to have a more elastic demand. In this case, in countries where rice takes up a large part of disposable income, higher prices might cause people to cut back on their consumption and seek cheaper alternatives.

My instinct is that the market demand for rice as a basic product is likely to have a low price elasticity of demand but this might depend on the stage of development that a nation has reached.

In developed countries where per capita incomes are high, rice and rice-related products are relatively cheap and affordable although there are many subsitutes. In emerging countries where per capita incomes are much lower, rice is an essential part of the diet and I argue that this characteristic of the product might outweigh the high percentage of income allocated to rice consumption.

The time period allowed following a price change also affects price elasticity of demand – demand tends to be more price elastic, the longer that consumers have to respond to a price change. They may search for cheaper substitutes and switch their spending. So if the rise in the price of rice was seen as being long term in nature, people would have an incentive and time to change their consumption decisions and find substitutes.