Elasticity of demand An elastic demand or elastic supply is one in which the elasticity is greater than one, indicating a high responsiveness to changes in price.. Concepts and calculati
DEMAND
Demand and Law of demand
Quantity demanded refers to the total amount of goods and services that consumers desire and are prepared to purchase within a specific timeframe A key element influencing the demand curve is the price consumers are willing to pay for a product or service, regardless of whether it aligns with the market equilibrium price.
- The relationship between the quantity demanded of a good or service in the marketplace by consumers, and its price is called the demand curve When demand changes
The law of demand is a key principle in economics that, alongside the law of supply, helps to explain how market economies distribute resources and establish the prices of goods and services in our daily transactions.
The law of demand asserts that, assuming all other factors remain unchanged, an increase in the price of a good leads to a decrease in the quantity demanded, while a decrease in price results in an increase in the quantity demanded.
➔It suggests that the quantity purchased varies inversely with price In other words, the higher the price, the lower the quantity demanded
Diminishing marginal utility explains consumer behavior, where individuals prioritize their most urgent needs when using the initial units of an economic good As they acquire more units, each additional purchase addresses progressively less critical needs, reflecting a decline in the perceived value of each subsequent unit.
When consumers buy goods, the value they place on each additional unit decreases, leading to a lower willingness to pay for it This principle highlights that as individuals acquire more of a product or service, each subsequent unit is typically utilized for less valued purposes compared to the previous ones.
3 Demand schedule and demand curve
- Changes in price can be reflected in movement along a demand curve, but by themselves, they don't increase or decrease demand
- The shape and magnitude of demand shifts in response to changes in consumer preferences, incomes, or related economic goods, not usually to changes in price
A market demand curve illustrates the total quantity of a good that consumers are willing to purchase at various price levels, always sloping downward Each point on the curve, such as A, B, and C, represents the quantity demanded (Q) at a specific price (P) For instance, at point A, the quantity demanded is low (Q1) while the price is high (P1), indicating that as prices rise, consumer demand decreases, and conversely, demand increases when prices fall.
When gasoline prices rise, consumers tend to decrease their usage by consolidating errands, opting for carpooling or public transport, and planning closer weekend trips This behavior illustrates the law of demand, which describes the inverse relationship between price and quantity demanded, assuming all other influencing factors remain constant.
The demand curve illustrates the relationship between quantity and price per gallon, with quantity represented on the horizontal axis and price on the vertical axis This setup deviates from the conventional mathematical norm where the independent variable (x) is placed on the horizontal axis and the dependent variable (y) on the vertical axis.
4 Exceptions to the Law of Demand
Economic laws differ from universal laws in mathematics and physics, as they are not absolute For instance, the law of demand has exceptions; certain goods do not exhibit the typical inverse relationship between price and quantity Consequently, the demand curve for these specific goods slopes upward.
Giffen goods are a type of inferior good that significantly impacts a consumer's income and lack close substitutes Proposed by Scottish economist Sir Robert Giffen in the 19th century, these goods challenge the traditional law of demand, as their prices rise when the quantity demanded increases Despite their intriguing nature, Giffen goods primarily remain a theoretical concept, with limited empirical evidence supporting their existence in real-world scenarios.
Veblen goods, named after economist Thorstein Veblen, are a unique category of luxury items that defy the traditional law of demand These goods, which signify the economic and social status of their owners, become more desirable as their prices rise Consequently, consumers are often more inclined to purchase Veblen goods, such as luxury cars, expensive wines, and designer clothing, when their costs increase.
Elasticity of demand
Elastic demand or supply occurs when the elasticity exceeds one, signifying a strong sensitivity to price fluctuations Conversely, elasticities below one reflect a low sensitivity to price changes, which is characteristic of inelastic demand or supply.
Measure of the responsiveness of Q dor Qs to a change in one of its determinants
How much the quantity demanded of a good responds to a change in the price of that good Loosely speaking, it measures the price-sensitivity of buyers’ demand
- Point elasticity is elasticity at a point on the demand curve
- nterval elasticity is the elasticity over a finite range of the demand curve In essence, it is elasticity between two different prices
- The price elasticity of demand is always negative
- On a linear demand curve, the price elasticity of demand values at different points are different The higher the ordinate point, the greater the absolute elasticity value
- Distinguish between elasticity and slope
- Slope: slope is an exact numerical measure of the change in Y corresponding to the change in
- Elasticity of the demand curve: equal to the product of the slope and the ratio of price and output
The price elasticity coefficient of demand can exhibit five distinct values, with one being less elastic demand In this scenario, a 1% change in price results in a less than 1% change in the quantity demanded, indicating that consumers are less sensitive to price fluctuations Common examples include essential commodities such as gasoline, electricity, and water.
Essential goods are items that are less replaceable and have a relatively elastic demand, meaning that a 1% change in price results in a greater than 1% change in the quantity demanded Examples of such goods include pork, beef, vermicelli, pho, and mobile phone networks.
- Consumers are very sensitive to price changes
Goods with many substitutes exhibit unit elastic demand, where a 1% change in price results in a corresponding 1% change in quantity demanded Conversely, demand can also be completely inelastic, meaning that changes in price do not affect the quantity demanded at all, as seen with essential items like special medicines and passport services.
- Consumers always buy a fixed quantity Q1 at all prices
- The demand curve is a straight line parallel to the vertical axis
Inelastic goods are those that cannot be substituted, exhibiting perfectly elastic demand This means that when prices remain constant, the quantity demanded can be exceedingly high Conversely, even a slight increase in price can lead to a complete drop in quantity demanded, highlighting the sensitivity of consumers to price changes for these essential items.
In a perfectly competitive market with infinite substitutes, consumers consistently purchase goods at a single price, P1 The demand curve for these products is a straight line parallel to the horizontal axis, indicating that the quantity demanded remains constant regardless of price fluctuations.
3 Factors affecting the price elasticity of demand
- Time period of price change
- Percentage of budget spent on merchandise
- Total revenue (TR) is the total amount of money earned from selling goods, calculated by the product of the selling price and the selling quantity
- Helps sellers decide whether to increase or decrease prices to increase total revenue if they know the EDP of that good
- Estimate price changes to eliminate market surpluses and shortages.
The Price Elasticity of Demand
1 The Price Elasticity of Demand and Its Determinants
Price Elasticity of Demand measures how the quantity demanded of a product changes in response to price fluctuations When demand is elastic, significant changes in price lead to considerable shifts in the quantity demanded Conversely, if demand is inelastic, the quantity demanded changes only slightly with price alterations.
Price elasticity of demand is influenced by several key factors The availability of substitutes plays a crucial role; goods with close alternatives exhibit more elastic demand, as consumers can easily switch between them, such as opting for tea when coffee prices rise Additionally, the distinction between necessities and luxuries affects elasticity; necessities like doctor visits tend to have inelastic demand, while luxuries like sailboats show greater elasticity, with demand significantly decreasing as prices rise The definition of the market also impacts elasticity; narrowly defined markets generally have more elastic demand due to the availability of substitutes, whereas broadly defined markets, like food, tend to be less elastic Lastly, the time horizon is important, as demand for goods becomes more elastic over longer periods; for example, while gasoline demand may only drop slightly after a price increase, over time, consumers adapt by choosing more fuel-efficient vehicles or alternative transportation methods, leading to a more substantial decrease in demand.
2 Computing the Price Elasticity of Demand
Price Elasticity of Demand expressed mathematically is as follows:
Price elasticity of demand is calculated by dividing the percentage change in quantity demanded by the percentage change in price To determine the percentage change in quantity demanded, use the formula: (Change in Quantity Demanded ÷ Initial Quantity Demanded) x 100% Similarly, the percentage change in price is calculated as (Change in Price ÷ Initial Price) x 100% Understanding these calculations is essential for analyzing consumer behavior in response to price changes.
In this case the Price Elasticity of Demand: o % change in Quantity Demand = (-50 100) x 100% = -50%÷ o % change in Price = (10 50) x 100% = 20%÷
➔Therefore the Price Elasticity of Demand = -50% ÷20% = -2.5
The quantity demanded of a good decreases as its price increases, illustrating an inverse relationship This principle is reflected in the price elasticity of demand formula, where the percentage change in quantity demanded is always opposite in sign to the percentage change in price Consequently, the calculated price elasticity of demand coefficient consistently yields a negative result.
- The larger the result of calculating the price elasticity coefficient of demand, the higher the response level of quantity demanded to price
3 The Midpoint Method: A Better Way to Calculate Percentage Changes and Elasticities
To calculate elasticity, we employ the midpoint method, which utilizes the average percentage change in both quantity and price This approach is represented by specific equations that facilitate accurate elasticity measurement.
The midpoint method offers a consistent measure of elasticity between two price points, regardless of whether prices increase or decrease This is achieved by utilizing the same base for calculations in both scenarios, ensuring accurate comparisons.
- Using the midpoint method: o % change in Quantity Demand = [ (100-50) / ( 100+50) 2 ] x 100% = 66,7%÷ o % change in Price = [ (60-50) / ( 60+50) 2 ] x 100% = 18,2%÷ o Therefore the Price Elasticity of Demand = 66,7% ÷ 18,2% = 3,7%
4 The Variety of Demand Curves a Economists classify demand curves according to their elasticity
- Demand elastic when the elasticity is greater than 1: the quantity moves proportionately more than the price
- Demand inelastic when the elasticity is less than 1: the quantity moves proportionately less than the price
- Unit elasticity: the elasticity is exactly 1, the percentage change in quantity equals the percentage change in price, and demand
• There are two special cases of demand curve
- Demand is perfectly inelastic, price elasticity of demand = 0, and the demand curve is vertical
When the price elasticity of demand approaches infinity, the demand curve becomes horizontal, indicating that even minor price changes result in significant fluctuations in the quantity demanded.
5 Total Revenue and the Price Elasticity of Demand
- The rate of expenditure income for goods
- The time period when the price changes
• The derivative of the total revenue according to the price depends on the value of elasticity
When the absolute value of elasticity is less than 1, indicating an inelastic demand curve, price and total revenue move in the same direction Conversely, when the absolute elasticity exceeds 1, signifying an elastic demand curve, price and total revenue change in opposite directions.
E =1 TR not change TR not change
6 Elasticity and Total Revenue along a Linear Demand Curve
- The slope of a linear demand curve is constant, but its elasticity is not
- The demand curve becomes more elastic at higher prices
• The Income Elasticity of Demand: measures how the quantity demanded changes as consumer income changes
- Higher income raises the quantity demanded Because quantity demanded and income move in the same direction, normal goods have positive income elasticities (Normal goods: income elasticity > 0)
Inferior goods, like bus rides, exhibit a unique relationship with consumer income; as income increases, the demand for these goods decreases This inverse correlation results in a negative income elasticity, indicating that higher earnings lead to a lower quantity demanded for inferior goods In essence, when consumers have more disposable income, they tend to opt for alternatives rather than these lower-quality options.
• The cross-price elasticity of demand: measures how the quantity demanded of one good responds to a change in the price of another good
Substitutes are products that can be used interchangeably, like hamburgers and hot dogs When the price of hot dogs rises, consumers are likely to choose hamburgers instead This relationship indicates that as the price of one substitute increases, the demand for the other also increases, resulting in a positive cross-price elasticity.
Complements are products that are commonly used in conjunction, like computers and software When the price of computers rises, it leads to a decrease in the demand for software, which is reflected in the negative cross-price elasticity between these goods.
SUPPLY
Supply and law of supply
In economics, the quantity supplied refers to the amount of goods or services that suppliers are willing to produce and sell at a specific market price This quantity can differ from the total supply, as changes in price affect how much producers bring to market, a concept known as the price elasticity of supply The quantity supplied is influenced by the price level, which can be regulated through mechanisms like price ceilings and floors A price ceiling, such as rent controls in New York, limits the maximum price suppliers can charge, often resulting in reduced supply as producers are less inclined to sell at capped prices Conversely, a price floor, exemplified by minimum wage laws, establishes a minimum price that suppliers cannot go below, affecting the overall supply dynamics in the market.
- The law of supply is a basic economic concept It states that an increase in the price of goods or services results in an increase in their supply
The law of demand indicates that, all else being equal, an increase in the price of a good leads to a higher quantity supplied, as rising prices enhance profitability for businesses, encouraging them to produce more Conversely, when prices decrease, the quantity supplied diminishes, as suppliers are less motivated to produce due to reduced profit opportunities.
3 Supply schedule and Supply curve
- Supply in a market can be depicted as an upward-sloping supply curve that shows how the quantity supplied will respond to various prices over a period of time
The chart illustrates the law of supply through an upward-sloping supply curve, with points A, B, and C representing specific quantities and prices Each point on the curve demonstrates a direct relationship between quantity supplied (Q) and price (P), indicating that at point A, the quantity supplied is Q1 at a price of P1, and this pattern continues for the other points.
The supply curve slopes upward as suppliers have the flexibility to determine production levels over time However, at any specific moment, the quantity of goods available for sale is fixed, leaving sellers with the choice to either sell or withhold their inventory Ultimately, consumer demand dictates pricing, and sellers must charge based on what the market can support.
As consumer demand increases, prices tend to rise, prompting suppliers to allocate additional resources for production or allowing new suppliers to enter the market, thereby boosting the quantity supplied In a competitive market, demand plays a crucial role in determining prices, while suppliers adjust their output based on the anticipated price they will receive.
A pizzeria that offers both pizza and pasta may respond to a rise in pizza prices by reallocating its resources to boost pizza production while reducing pasta offerings As pizza prices continue to increase, the pizzeria can enhance its profits by supplying more pizzas This dynamic relationship is illustrated by a supply curve, which depicts the quantity of pizzas produced at varying price levels.
As prices and production rise, a pizzeria may hit its maximum output capacity due to limited equipment, such as ovens that are consistently in use To boost supply, the pizzeria might invest in an additional oven Concurrently, the elevated prices encourage new entrepreneurs to open pizzerias, contributing to an overall increase in market supply.
4 Exceptions to Law of supply
Not all business scenarios are governed by the law of supply, as there are several exceptions where the availability of goods and services is not influenced by pricing Here are some of the most prevalent situations.
Economies of scale allow large producers to lower the costs of goods and services by increasing production efficiency This reduction in costs can enhance profitability and competitiveness in the market.
A business may adjust its market focus by temporarily increasing the supply of certain products at reduced prices to clear out remaining stock and raw materials This strategy can also serve as an emergency measure to quickly generate cash if needed.
• Monopoly: When there's only a single supplier of a good or service, the company may be able to increase or decrease its supply or pricing irrespective of external factors
• Competitive pricing: In a highly competitive market, businesses may increase the supply of their products while reducing the price to capture market share
Businesses often increase the supply of perishable goods as they approach their expiration date to recover production costs before the items become unsellable.
• One-of-a-kind goods: Handmade art or other rare goods cannot be easily reproduced, so the supply cannot expand even if the price rises
Inelastic supply refers to the difficulty in quickly adjusting the availability of certain goods, particularly agricultural products, even when prices increase For instance, it can take months or years for crops to mature and be ready for sale A prime example is an apple farmer who plants new trees; they will not see any harvest for several years, highlighting the inherent time constraints in agricultural supply.
Elasticity of Supply
1 What is the elasticity of supply
The law of supply indicates that an increase in the price of a good or service leads to an increase in its supply Conversely, a decrease in price results in a reduction in the quantity supplied.
When housing prices surge, construction companies face challenges in rapidly increasing the number of homes built This is due to the need for hiring additional workers and investing in more capital, which complicates their ability to quickly respond to the rising demand.
2 Types of Elasticity of Supply a Perfectly Elastic Supply
Price Elasticity of Supply is characterized as perfectly elastic when a commodity has an infinite supply at a specific price, but any slight increase in price results in the supply dropping to zero.
Perfectly elastic supply occurs when suppliers are only willing to sell their products at high prices, resulting in an infinite price elasticity (E = S ∞) In this scenario, the supply curve is represented as a horizontal straight line that runs parallel to the X-axis.
Quantity supplied can be OQ, OQ or OQ at the same price as OP 1, 2
At a price of ₹20, the quantity supplied can vary between 150, 250, or 350 units It's important to note that perfectly inelastic supply is a theoretical concept In contrast, highly elastic supply refers to scenarios where supply significantly changes in response to price variations.
Price Elasticity of Supply is considered more than unit elastic when the percentage change in supply exceeds the percentage change in price, resulting in a price elasticity of supply greater than 1 (ES > 1) In these instances, the supply curve intersects the Y-axis, indicating a strong responsiveness of supply to price changes.
The quantity supplied increases from OQ to OQ as the price rises from OP to OP Since QQ is proportionately greater than PP, the elasticity of supply exceeds 1.
The quantity supplied increases by 100% due to a 50% increase in p rice c Unitary Elastic Supply
Price Elasticity of Supply is characterized as unit elastic when a change in price corresponds exactly to a change in quantity supplied, resulting in a price elasticity of supply of 1 (ES = 1) In this scenario, the supply curve is represented as a straight line that intersects the origin.
As the price increases from OP to OP, the quantity supplied increases from OQ to OQ This proportional change, where QQ is equal to PP, indicates that the elasticity of supply is equal to 1.
The quantity supplied rises by 50% due to a 50% increase in price d Less than Unit Elastic Supply/Less Elastic Supply
Price Elasticity of Supply is considered inelastic when the percentage change in supply is smaller than the percentage change in price, resulting in a value of less than one (ES < 1) In this scenario, the supply curve intersects the X-axis, indicating a limited responsiveness of supply to price changes.
As prices increase from OP to OP, the quantity supplied increases from OQ to OQ Since QQ is proportionately less than PP, this indicates that the elasticity of supply is less than 1.
The quantity supplied rises by 20% due to a 50% increase in price e Perfectly Inelastic Supply
Price Elasticity of Supply is characterized as perfectly inelastic when the quantity supplied remains constant regardless of price fluctuations In this scenario, the supply does not vary with changes in price, resulting in a price elasticity of zero (E = 0) Consequently, the supply curve is represented as a vertical straight line parallel to the Y-axis.
Quantity supplied remains the same at OQ, with the change in price from OP to OP to OP 1 2
Price (in ₹) Supply (in units)
The quantity supplied remains the same at 30 units, whether the price is ₹10, ₹20, or ₹30.
The price Elasticity of Supply
Elasticity of supply measures how the quantity supplied of a good or service responds to changes in its price Essentially, it indicates the degree to which supply adjusts when prices fluctuate.
1 The Price Elasticity of Supply and Its Determinants
Price elasticity of supply measures how the quantity supplied of a good or service reacts to changes in its market price Basic economic principles indicate that when the price of a good increases, its supply tends to rise, while a decrease in price typically leads to a reduction in supply.
- Goods and services can be either elastic or inelastic Elastic means the product is considered sensitive to price changes Inelastic means the product is not sensitive to price movements
The price elasticity of supply is significantly influenced by the time frame under consideration, with supply generally being more elastic in the long run compared to the short run In the short term, firms face limitations in adjusting production capacity, making the quantity supplied less responsive to price changes However, over longer periods, companies can construct new factories or shut down existing ones, allowing for greater flexibility Additionally, the market can see the entry of new firms and the exit of those that are no longer viable, resulting in a substantial response of quantity supplied to price fluctuations in the long run.
2 Calculating Price Elasticity of Supply
- Economists compute the price elasticity of supply as the percentage change in the quantity supplied divided by the percentage change in the price
When an apartment's rental price rises from $650 to $700 per month, the supply of available units increases from 10,000 to 13,000 This represents a percentage increase in apartment supply of 30% The price sensitivity of the apartment market can be assessed by analyzing this change in supply relative to the price increase, indicating a responsive market to rental price fluctuations.
We calculate the percentage change in quantity supplied as: o percentage change in quantity = [(13,000 - 10,000)/{(13,000 + 10,000)/2}] x 100 26.1%
Similarly, we calculate the percentage change in price as: o percentage change in price = [(700 - 650)/{(700 + 650)/2}] x 100 = 7.4%
➔In this case, the price elasticity of supply is price elasticity of supply = 26.1% / 7.4% 3.53
3 The Variety of Supply Curves
Supply curves tend to form in a variety of types, namely: perfectly inelastic supply, perfectly elastic supply, inelastic supply, unit elastic supply, elastic supply a Perfectly inelastic supply
In cases of zero elasticity, supply is perfectly inelastic, represented by a vertical supply curve As elasticity increases, the supply curve becomes flatter, indicating that the quantity supplied becomes more responsive to price changes.
In the scenario of perfectly elastic supply, the supply curve is horizontal, indicating that even minor price fluctuations result in significant changes in the quantity supplied This occurs when the price elasticity of supply approaches infinity, highlighting the sensitivity of supply to price changes.
The Price Elasticity of Supply for relatively inelastic supply ranges from zero to one, indicating that the percentage change in quantity supplied is less than the percentage change in price In this context, unit elastic supply represents a situation where the percentage change in quantity supplied is equal to the percentage change in price.
Unitary Elasticity Supply has a price elasticity supply of one, where the quantity supplied changes by the same percentage as the price change e Elastic supply
A price elasticity supply greater than one means supply is relatively elastic, where the quantity supplied changes by a larger percentage than the price change.
Applications of Supply, Demand, and Elasticity
1 Can Good News for Farming Be Bad News for Farmers?
The introduction of a new hybrid wheat variety boosts production per acre by 20%, shifting the supply curve to the right and increasing the quantity sold However, this surge in supply causes wheat prices to decline Total revenue for farmers, calculated as price multiplied by quantity, is influenced by the price elasticity of demand Given that the demand for wheat is typically inelastic, the price drop results in a smaller increase in quantity sold, leading to a decrease in total revenue from $300 to $220 Consequently, the discovery of the hybrid wheat ultimately reduces farmers' total revenue from crop sales.
• An Increase in Supply in the Market for Wheat
Advancements in farm technology can boost wheat supply, shifting it from S1 to S2, which leads to a decrease in wheat prices Due to the inelastic nature of wheat demand, the quantity sold increases only slightly, from 100 to 110 units, while the price drops significantly from $3 to $2 Consequently, farmers experience a decline in total revenue, dropping from $300 to $220.
2 Why OPEC Fail to Keep the Price of Oil High ?
The oil market has experienced significant price fluctuations over the past few decades, largely driven by the decisions of the Organization of the Petroleum Exporting Countries (OPEC) In the 1970s, OPEC's agreement to raise oil prices led to a doubling of prices by 1981 However, sustaining these elevated prices became challenging, resulting in a notable decline by 1986.
In the 21st century, oil price fluctuations have transitioned from being primarily influenced by OPEC supply restrictions to being driven by technological advancements such as fracking These changes have significantly impacted both short-term and long-term supply and demand dynamics Additionally, the inelastic nature of oil supply and demand is attributed to the slow adjustments in oil reserves, extraction capacity, and consumer purchasing behaviors.
When oil supply decreases, the market response varies based on the time frame In the short term, both supply and demand are relatively inelastic, leading to a significant price increase when the supply curve shifts from S1 to S2 Conversely, in the long run, supply and demand become more elastic, resulting in a smaller price increase for the same shift in the supply curve.
3 Does Drug Interdiction Increase or Decrease Drug-Related Crime?
The government's efforts to combat drug-related crime through increased drug interdiction primarily affect drug sellers rather than buyers By raising the costs associated with selling drugs, interdiction decreases the quantity supplied at any given price, while demand for drugs remains constant Consequently, this approach may lead to a reduction in drug-related crime by limiting the availability of illegal substances in the market.
Drug interdiction effectively decreases the supply of drugs, leading to higher total expenditures by users due to inelastic demand, despite a reduction in drug consumption In contrast, drug education lowers demand, resulting in decreased prices and quantities, ultimately reducing the overall spending by drug users.