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Questions and Answers
What happens to the supply of a profit-oriented firm when it needs to increase output?
What happens to the supply of a profit-oriented firm when it needs to increase output?
Under what condition do firms tend to have an elastic supply?
Under what condition do firms tend to have an elastic supply?
What is the effect of barriers to entry on supply?
What is the effect of barriers to entry on supply?
What happens to price and output when supply is more elastic?
What happens to price and output when supply is more elastic?
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What can assist firms in expanding in response to increasing demand without raising prices more than output?
What can assist firms in expanding in response to increasing demand without raising prices more than output?
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What happens when there are barriers to entry, such as patents or high marketing costs?
What happens when there are barriers to entry, such as patents or high marketing costs?
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Why might firms be slow to adjust their supply in response to an increase in demand?
Why might firms be slow to adjust their supply in response to an increase in demand?
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What is the importance of the degree of suppliers' flexibility?
What is the importance of the degree of suppliers' flexibility?
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What is the effect of a more elastic supply on the market equilibrium?
What is the effect of a more elastic supply on the market equilibrium?
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What can lead to a slow adjustment of supply to demand?
What can lead to a slow adjustment of supply to demand?
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Study Notes
Elasticity of Demand
- Elasticity measures how one dependent variable responds to a change in another independent variable.
- Elasticity of demand refers to the responsiveness of quantity demanded of a good to a change in its own price, income, price of other goods, advertising, population, etc.
Price Elasticity of Demand (PED)
- PED is a numerical value measuring the responsiveness of quantity demanded of a good to a change in its own price.
- PED is calculated by the formula: (Percentage change in quantity demanded) / (Percentage change in price)
- PED can be classified into:
- Perfectly inelastic (PED = 0): quantity demanded remains unchanged despite any change in price.
- Inelastic (PED < 1): quantity demanded varies less-than-proportionately to the change in price.
- Unitary elastic (PED = -1): the percentage change in quantity demanded is equal to the percentage change in price.
- Elastic (PED > 1): quantity demanded varies more-than-proportionately to the change in price.
- Perfectly elastic (PED = ∞): a price rise causes demand to disappear.
Determinants of PED
- The number and closeness of substitute/competitor goods
- The proportion spent on the commodity relative to income
- The degree of necessity
- Time period
Who Requires Knowledge of PED?
- The business sector: to determine the effect of price changes on quantity demanded and revenue.
- The government: to influence consumption through taxes or subsidies.
- Trade unions: to estimate the demand for workers following a rise in wages.
Elasticity of Demand Along a Linear Demand Curve
- PED varies along the entire length of the demand curve.
- PED rises as we move up the demand curve, i.e., at higher price levels.
Income Elasticity of Demand (YED)
- YED is a numerical value measuring the degree of consumers' responsiveness to a given change in income.
- YED is equal to the percentage change in demand divided by the percentage change in income.
- If YED is negative, the product is an inferior good.
- If YED is positive and less than 1, the product is a necessity.
- If YED is positive and greater than 1, the product is a superior or luxury good.
Determinants of YED
- Degree of necessity
- The level of income of consumers
- The rate at which the desire for a good is satisfied as consumption increases
The Importance of YED
- YED provides information about how demand varies as income changes.
- YED is useful in planning for both business organizations and governments.
- YED can contribute to an understanding of patterns of specialization and development.
Cross-Price Elasticity of Demand (CED)
- CED is a numerical value measuring the degree of responsiveness of demand for good A to a change in the price of good B.
- CED is equal to the percentage change in the demand for commodity A divided by the percentage change in the price of good B.
- If CED is positive, the two goods are in competitive demand (substitutes).
- If CED is negative, the two goods are in joint demand (complements).
- If CED is zero, the two products are unrelated (independent goods).
Determinants of CED
- Closeness of a substitute or a complement
- The better are the substitutes or complementary goods, the bigger will be the value of the cross-price elasticity.
The Importance of CED
- CED is useful in identifying the impact of rival pricing strategies on the demand for a product.
- CED helps firms to tie consumers to buy not just one of their products but a whole range of complementary ones.
Price Elasticity of Supply (PES)
- PES is a numerical measure of the responsiveness of supply to any given change in the price of the commodity caused by variations in demand alone.
- PES is calculated by dividing the percentage change in the quantity supplied by the percentage change in product's own price.
- The degree of suppliers' responsiveness may vary from zero to infinity.
Determinants of PES
- Time period
- The amount that costs rise as output rises
- Firm's objective
- Certainty or uncertainty
- Barriers to entry
The Importance of PES
- The degree of suppliers' flexibility is of great importance in determining the effect of changes in demand on market equilibrium prices and quantities.
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Description
Explore the concept of elasticity, which measures the responsiveness of one variable to a change in another. Learn about price elasticity of demand and its significance in economics.
