Principle of Economics Chapter 4 PDF

PRINCIPLE OF ECONOMICS NOOR SA'ADAH SABUDIN SEFB CHAPTER 4 Elasticity INTHISLECTURE Price Elasticity of Demand: Formula, Degree, Elasticity and TR and Determinants. Cross Elasticity of Demand Income Elasticity of Demand...

PRINCIPLE OF ECONOMICS NOOR SA'ADAH SABUDIN SEFB CHAPTER 4 Elasticity INTHISLECTURE Price Elasticity of Demand: Formula, Degree, Elasticity and TR and Determinants. Cross Elasticity of Demand Income Elasticity of Demand Price Elasticity of Supply: Formula, Degree and Determinants After studying this chapter, you will be able: To calculate and to interpret the price elasticity of demand. To relate price elasticity of demand with total revenue (TR). To explain the price elasticity of demand determinants. To calculate the cross-elasticity of demand After studying this chapter, you will be able: To calculate the cross-elasticity of demand. To identify the types of goods from the value of cross elasticity of demand. To calculate the income-elasticity of demand. To identify the types of goods from the value of income elasticity of demand. After studying this chapter, you will be able: To calculate the price elasticity of supply. To interpret the value of price elasticity of supply. To explain the price elasticity of supply determinants. In December 2021, taxi fares in Singapore rose by 20 percent and customer numbers fell by 30 percent. But by April 2022, customers returned and cabbies’ earnings were up. To answer these and similar questions, we use the neat tool that you study in this chapter: Elasticity PRICE ELASTICITY OF DEMAND You know that when supply decreases, the equilibrium price rises and the equilibrium quantity decreases. But does the price rise by a large amount and the quantity decrease by a little? Or does the price barely rise and the quantity decrease by a large amount? The answer depends on the responsiveness of the quantity demanded of a good to a change in its price. PRICE ELASTICITY OF DEMAND You might think about the responsiveness of the quantity demanded of a good to a change in its price in terms of the slope of the demand curve. If the demand curve is steep, the price rises by a lot; if the demand curve is almost flat, the price barely rises. But the slope of a demand curve depends on the units in which we measure the price and the quantity. We can choose these units to make the demand curve steep or flat. PRICE ELASTICITY OF DEMAND To measure responsiveness we need a measure that is independent of units of measurement. Elasticity is such a measure. PRICE ELASTICITY OF DEMAND The price elasticity of demand is a measure of how much the quantity demanded of a good responds to a change in the price of that good. In other words, the price elasticity of demand measures the sensitivity/responsiveness of the quantity demanded due to a change in its price. When we talk about elasticity, that responsiveness is always measured in percentage terms. Specifically, the price elasticity of demand is the percentage change in quantity demanded due to a percentage change in the price. PRICE ELASTICITY OF DEMAND Calculating Price Elasticity of Demand The price elasticity of demand is computed as the percentage change in the quantity demanded divided by the percentage change in price using this formula: PRICE ELASTICITY OF DEMAND Calculating Price Elasticity of Demand: Example If the price of an ice cream cone increases from RM2.00 to RM2.20 and the amount you buy falls from 10 to 8 cones, then your elasticity of demand would be calculated as: Percentage change in quantity demanded Price elasticity of demand = Percentage change in price (10  8)  100 20% 10  2 (2.20  2.00)  100 10% 2.00 PRICE ELASTICITY OF DEMAND The Midpoint Method: A Better Way to Calculate Percentage Changes and Elasticities The midpoint formula is preferable when calculating the price elasticity of demand because it gives the same answer regardless of the direction of the price change. (Q2  Q1 ) /[(Q2  Q1 ) / 2] Price elasticity of demand = ( P2  P1 ) /[( P2  P1 ) / 2] Or Price elasticity of demand = (Qd2 – Qd1) / ½ (Qd2 – Qd1) (P2 – P1) / ½ (P2 – P1) PRICE ELASTICITY OF DEMAND The Midpoint Method: A Better Way to Calculate Percentage Changes and Elasticities Example: If the price of an ice cream cone increases from RM2.00 to RM2.20 and the amount you buy falls from 10 to 8 cones, then your elasticity of demand, using the midpoint formula, would be calculated as: (Q2  Q1 ) /[(Q2  Q1 ) / 2] Price elasticity of demand = ( P2  P1 ) /[( P2  P1 ) / 2] (10  8) (10  8) / 2 22%   2.32 (2.20  2.00) 9.5% (2.00  2.20) / 2 PRICE ELASTICITY OF DEMAND Why Midpoint Method Better? For the price Price Demand Curve for Tacos elasticity to be a useful measure, we should come up with $1.10 a the same result between points a and 0.90 b b as we get between b and a. To do this we must take the average of the initial price and the new price and D use that as the base in computing the 0 95 105 percent change in Thousands per day price Price elasticity between a and b = 10% / - 20% = - 0.5 PRICE ELASTICITY OF DEMAND Why Midpoint Method Better? Assumed price decrease from P1 = $3 to P2 = $2. Quantity increased from 5 to 10. Using original method, we will get: BUT different answer if assumed price increase from P1 = $2 to P2 = $3. Quantity decreased from 10 to 5. PRICE ELASTICITY OF DEMAND Why Midpoint Method Better? Solution: Mid-point formula Because the average quantity and average price are used as a base for computing percent change, the same elasticity results whether going from the higher price to the lower price or the other way around. PRICE ELASTICITY OF DEMAND Calculating Price Elasticity of Demand Average Price and Quantity By using the average price and average quantity, we get the same elasticity value regardless of whether the price rises or falls. Percentages and Proportions The ratio of two proportionate changes is the same as the ratio of two percentage changes. %DQ / %DP = DQ / DP PRICE ELASTICITY OF DEMAND Calculating Price Elasticity of Demand Minus Sign and Elasticity Because price and quantity demanded are inversely related, the price elasticity of demand has a negative sign. But it is the magnitude, or absolute value, that reveals how responsive the quantity change has been to a price change. For example, absolute value of the elasticity will be referred to as 0.5 rather than –0.5 PRICE ELASTICITY OF DEMAND Calculating Price Elasticity of Demand Minus Sign and Elasticity NOTE: Which one is more elastic? More elastic Less elastic In negative value –5 –4 –3 –2 –1 Less elastic More elastic In absolute value 1 2 3 4 5 PRICE ELASTICITY OF DEMAND Calculating Price Elasticity of Demand A Units-Free Measure Elasticity is a ratio of percentages, so a change in the units of measurement of price or quantity leaves the elasticity value the same. PRICE ELASTICITY OF DEMAND Calculating Price Elasticity of Demand: Example PRICE ELASTICITY OF DEMAND Degree of Elasticity Demand can be perfectly inelastic, inelastic, unit elastic, or elastic, and can range from zero to infinity (perfectly elastic. For example, if the quantity demanded doesn’t change when the price changes, the price elasticity of demand is zero and the good has a perfectly inelastic demand. PRICE ELASTICITY OF DEMAND Degree/Types of Elasticity PRICE ELASTICITY OF DEMAND Degree/Types of Elasticity PRICE ELASTICITY OF DEMAND Degree/Types of Elasticity Elastic Demand (Ɛd > 1) The percentage change in the quantity demanded is greater than the percentage change in price (%∆Q > % ∆P) If the price elasticity of demand is greater than 1, then the good has elastic demand. PRICE ELASTICITY OF DEMAND Degree/Types of Elasticity Elastic Demand (Ɛd > 1) Quantity demanded responds strongly to changes in price. For example Ɛd = 2, a 1% increase in P lead to a 2% decreases in Qd. Types of goods: a lots of substitute of goods (such as soap, toothpaste) PRICE ELASTICITY OF DEMAND Degree/Types of Elasticity PRICE ELASTICITY OF DEMAND Degree/Types of Elasticity Inelastic Demand (Ɛd < 1) The percentage change in quantity demanded is less than the percentage change in price. (%∆Q < % ∆P) If the price elasticity of demand is less than 1, then the good has inelastic demand. PRICE ELASTICITY OF DEMAND Degree/Types of Elasticity Inelastic Demand (Ɛd < 1) The percentage change in quantity demanded is less than the percentage change in price. (%∆Q < % ∆P) If the price elasticity of demand is less than 1, then the good has inelastic demand. PRICE ELASTICITY OF DEMAND Degree/Types of Elasticity PRICE ELASTICITY OF DEMAND Degree/Types of Elasticity Unitary Elastic Demand (Ɛd = 1) The percentage change in quantity demanded is equal to the percentage change in price. (%∆Q = % ∆P) If the price elasticity of demand is 1, then the good has unitary elastic demand. PRICE ELASTICITY OF DEMAND Degree/Types of Elasticity Unitary Elastic Demand (Ɛd = 1) Quantity demanded changes proportionately to price changes. For example Ɛd = 1, a 1% increase in P lead to a 1% decreases in Qd Types of goods: normal goods PRICE ELASTICITY OF DEMAND Degree/Types of Elasticity Perfectly Elastic Demand (Ɛd = ∞) A small percentage change in price causes an extremely large percentage change in quantity demanded (from buying all to buying nothing) (%∆ P → ∆Qd = ∞) Quantity demanded changes infinitely with any change in price. PRICE ELASTICITY OF DEMAND Degree/Types of Elasticity Perfectly Elastic Demand (Ɛd = ∞) For example Ɛd = ∞, a 1% increase in P lead lead Qd fell to zero. The demand curve is horizontal. Type of goods: too many close substitutes/too many vendors offer goods at the same place/time such as vegetables and fruits. PRICE ELASTICITY OF DEMAND Degree/Types of Elasticity PRICE ELASTICITY OF DEMAND Degree/Types of Elasticity Perfectly Inelastic Demand (Ɛd = 0) Quantity demanded does not change as price changes. (%∆ P → ∆Qd = 0) For example Ɛd = 0, a 1% increase in P, Qd unchanged. PRICE ELASTICITY OF DEMAND Degree/Types of Elasticity Perfectly Inelastic Demand (Ɛd = 0) Quantity demanded does not respond to price changes. The demand curve is vertical. Type of good: Necessities goods such as insulin for diabetic patients. PRICE ELASTICITY OF DEMAND Degree/Types of Elasticity PRICE ELASTICITY OF DEMAND The Determinants / Factors That Influence the Elasticity of Demand The elasticity of demand for a good depends on: The availability of close substitutes Necessities versus Luxuries The proportion of income spent on the good Time dimension/horizon Habits PRICE ELASTICITY OF DEMAND Availability of Close Substitutes Number of substitutes - The more substitutes for a good, the higher the price elasticity of demand; the fewer substitutes for a good, the lower the price elasticity of demand. Elastic: lot of substitutes, example: soft drinks (coke/F&N) Inelastic: less substitutes, example: rice PRICE ELASTICITY OF DEMAND Necessities versus Luxuries Necessities versus luxuries - Generally, the more that a good is considered a luxury (a good that we can do without) rather than a necessity (a good that we can’t do without), the higher the price elasticity of demand. Elastic: Luxuries goods such as exotic vacations or non necessities good such as home décor items (vases, flowers, painting). Inelastic: Necessities goods, such as food or housing PRICE ELASTICITY OF DEMAND Proportion of Income Spent on the Good The greater the percentage of one’s budget that goes to purchase a good, the higher the price elasticity of demand; the smaller the percentage of one’s budget that goes to purchase a good, the lower the price elasticity of demand. Elastic: large proportion of income. For example: car (RM40,000). If the price of car increases by 10% then the new price is RM44,000. Qd fall a lot. Inelastic: small proportion of income. For example: soap (RM2.00). If the price of soap increases by 10% then the new price is RM2.20, The Qd fall slowly. PRICE ELASTICITY OF DEMAND Time Dimension/Horizon The more time that passes (since the price change), the higher the price elasticity of demand for the good; the less time that passes, the lower the price elasticity of demand for the good. Elastic: long term. In long term, user has enough time to make adjustment to the Qd. For example: in the 1970’s, oil prices rise significantly. In the long term users make changes to look for alternative sources to replace oil such as hydro energy or sun energy. Inelastic: short term. In short term, user does not have enough time to make adjustment to the Qd. PRICE ELASTICITY OF DEMAND Habits The more people like/addicted to some product, the more inelastic the demand for that good. Elastic: not interested. For example: cigarette. If the price of cigarettes increase slightly, consumers will reduce a large number of Qd. Inelastic: very interested/addicted. For example: being a smoker/alcoholic. If the price of cigarette of alcohol increased with the large amount, they will reduce only a small amount of Qd. PRICE ELASTICITY OF DEMAND Price Elasticity of Demand Along a Straight- Line Demand Curve I In (a), the price elasticity of demand varies along the straight-line downward- sloping demand curve.  There is an elastic range to the curve (where Ed > 1) and an inelastic range (where Ed < 1). At the midpoint of any straight-line downward- sloping demand curve, price elasticity of demand is equal to 1 (Ed = 1) PRICE ELASTICITY OF DEMAND Price Elasticity of Demand Along a Straight- Line Demand Curve II Part (b) shows that in the elastic range of the demand curve, total revenue rises as price is lowered. In the inelastic range of the demand curve, further price declines result in declining total revenue. Total revenue reaches its peak when price elasticity of demand equals 1. PRICE ELASTICITY OF DEMAND Price Elasticity and Total Revenue The information on price elasticity of demand will be useful for the seller to adjust their selling price since it will affect the total revenue. Total Revenue (TR) = Price (P) x Quantity (Q) PRICE ELASTICITY OF DEMAND Price Elasticity and Total Revenue Price When the price is RM4, consumers will demand 100 units, and spend RM400 on this good. 4 P × Q = RM400 P (revenue) Demand 0 100 Quantity Q PRICE ELASTICITY OF DEMAND Price Elasticity and Total Revenue Elastic Demand and Total Revenue If demand is elastic, the percentage change in quantity demanded is greater than the percentage change in price. Elastic; Ed >1; %ΔQ >%ΔP; P↑→TR↓ P↓→ TR↑ PRICE ELASTICITY OF DEMAND Price Elasticity and Total Revenue Elastic Demand and Total Revenue Demand is elastic between points A and B. A fall in price, from P1 to P2, will increase the size of the total revenue rectangle from 0P1AQ1 to 0P2BQ2. A rise in price, from P2 to P1, will decrease the size of the total revenue rectangle from 0P2BQ2 to 0P1AQ1. In other words, when demand is elastic, price and total revenue are inversely related PRICE ELASTICITY OF DEMAND Price Elasticity and Total Revenue Elastic Demand and Total Revenue DEMAND IS ELASTIC Price Total Revenue RM20 x 10 = RM200 RM30 If seller increases price to RM30 New Total Revenue = RM30 x 5 = RM150 RM20 D TR =  RM50 D 5 10 Quantity Demanded  Price Elasticity and Total Revenue Elastic Demand and Total Revenue How Total Revenue Changes When Price Changes: Elastic Demand Price Price An Increase in price from … leads to an decrease in RM4 to RM5 … total revenue from RM200 to RM100 5 4 Demand Demand Revenue = RM200 Revenue = RM100 0 50 Quantity 0 20 Quantity PRICE ELASTICITY OF DEMAND Price Elasticity and Total Revenue Inelastic Demand and Total Revenue If demand is inelastic, the percentage change in quantity demanded is less than the percentage change in price. Inelastic; Ed < 1; %ΔQ < %ΔP; P↓→TR↓ P↑→ TR↑ PRICE ELASTICITY OF DEMAND Price Elasticity and Total Revenue Inelastic Demand and Total Revenue Demand is inelastic between points A and B. A fall in price, from P1 to P2, will decrease the size of the total revenue rectangle from 0P1AQ1 to 0P2BQ 2. A rise in price, from P2 to P1, will increase the size of the total revenue rectangle from 0P2BQ2 to 0P1AQ1. In other words, when demand is inelastic, price and total revenue are directly related. PRICE ELASTICITY OF DEMAND Price Elasticity and Total Revenue Inelastic Demand and Total Revenue DEMAND IS INELASTIC Price Total Revenue RM2 RM1 x 15 = RM15 If seller increases price to RM2 New Total Revenue RM1 = RM2 x 10 = RM20 D TR =  RM5 D 10 15 Quantity Demanded  Price Elasticity and Total Revenue Inelastic Demand and Total Revenue How Total Revenue Changes When Price Changes: Inelastic Demand Price Price An Increase in price from … leads to an Increase in RM1 to RM3 … total revenue from RM100 to RM240 3 Revenue = RM240 1 Revenue = RM100 Demand Demand 0 100 Quantity 0 80 Quantity PRICE ELASTICITY OF DEMAND Price Elasticity and Total Revenue Unit Elastic Demand and Total Revenue If demand is unit elastic, the percentage change in quantity demanded is equal to the percentage change in price. Unit Elastic; Ed =1; %ΔQ =%ΔP; P↑→TR unchanged P↓→TR unchanged PRICE ELASTICITY OF DEMAND Price Elasticity and Total Revenue Unit Elastic Demand and Total Revenue Price DEMAND IS UNITARY ELASTIC Total Revenue RM2 RM1 x 20 = RM20 If seller increases price to RM2 New Total Revenue RM1 = RM2 x 10 = RM20 D TR =  0 D 10 20 Quantity Demanded PRICE ELASTICITY OF DEMAND Price Elasticity and Total Revenue PRICE ELASTICITY OF DEMAND Price Elasticity and Total Revenue Elasticity of a Linear Demand Curve Price Demand is elastic; When price increases from demand is responsive to RM4 to RM5, TR declines 7 changes in price. from RM24 to RM20. 6 Elasticity is > 1 in this range. 5 4 Elasticity is < 1 in this range. Demand is inelastic; demand is 3 not very responsive to changes 2 in price. When price increases from 1 RM2 to RM3, TR increases from RM20 to RM24. 0 2 4 6 8 10 12 14 Quantity PRICE ELASTICITY OF DEMAND Price Elasticity and Total Revenue CROSS ELASTICITY OF DEMAND The cross elasticity of demand is a measure of the responsiveness of demand for a good to a change in the price of other goods (substitute or complement), ceteris paribus. The formula for calculating the cross elasticity is: CROSS ELASTICITY OF DEMAND Calculation Formula: ∆Qx / ½ (Qx1 + Qx2) ∆Py / ½ (Py1 + Py2) Example: Py1 =RM10 Qx1 =100 Py2 =RM12 Qx2 =120 Ɛc = 120-100/ ½ (100+120) =1 12-10 / ½ (10+12) The value of Ɛc = 1 is positive indicates that this product is substitute each other like tea and coffee. CROSS ELASTICITY OF DEMAND Type of Cross Elasticity of Demand Positive (Ɛc > 0) Definition: increase in a price of a good will cause increase in demand for other goods, vice versa. Px ↑, Qdy ↑ and Px↓ Qdy↓. For Example: Ɛc = 1.5. When the price if good x increased by 1%, then the quantity of demand of good y increased by 1.5%. Type of goods: substitute (such as Honda and Toyota cars). CROSS ELASTICITY OF DEMAND Type of Cross Elasticity of Demand Negative (Ɛc < 0) Definition: increase in a price of a good will cause decrease in demand for other goods, vice versa. Px ↑, Qdy↓ and Px↓ Qdy ↑. For Example: Ɛc = -1.8. When the price if good x increased by 1%, then the quantity of demand of good y decreased by 1.8%. Type of goods: complementary goods (such as camera and memory cards/ printer and computer) CROSS ELASTICITY OF DEMAND Type of Cross Elasticity of Demand Zero (Ɛc = 0) The increase/decrease of a good will not affect the demand for other goods. For example: Ɛc = 0. When the price of good x increased by 1%, then demand for good y does not change. Type of goods: goods that are not related (camera and car/shoe and petrol) CROSS ELASTICITY OF DEMAND This figure shows the increase in the quantity of pizza demanded when the price of a burger (a substitute for pizza) rises. The figure also shows the decrease in the quantity of pizza demanded when the price of a soft drink (a complement of pizza) rises. INCOME ELASTICITY OF DEMAND Your Expenditure and Your Elasticity  If your demand is elastic, a 1 percent price cut increases the quantity you buy by more than 1 percent and your expenditure on the item increases.  If your demand is inelastic, a 1 percent price cut increases the quantity you buy by less than 1 percent and your expenditure on the item decreases.  If your demand is unit elastic, a 1 percent price cut increases the quantity you buy by 1 percent and your expenditure on the item does not change. INCOME ELASTICITY OF DEMAND The income elasticity of demand measures how the quantity demanded of a good responds to a change in income, ceteris paribus. The formula for calculating the income elasticity of demand is INCOME ELASTICITY OF DEMAND Calculation Example: supposed income increased from RM 500 to RM600 per month, and consequently the demand for good x increased from 20 units to 30 units per month. Calculate the income elasticity of demand. Ɛy = ∆Qd / ½ (Qd1 + Qd2) ∆Y / ½ (Y1 + Y2) Ɛy = 30-20/ ½ (20+30) = 2.2 600-500/ ½ (500+600) Since Ɛy>1, then the demand for good x is also known as income elastic demand. INCOME ELASTICITY OF DEMAND Type of Income Elasticity of Demand High income elasticity of demand (Ɛy > 1) In this case, increase in income is accompanied by relatively larger increase in quantity demanded. For example, 20% increase in Qd due to 10% increase in Y. Demand is income elastic and the good is a normal good INCOME ELASTICITY OF DEMAND Type of Income Elasticity of Demand Unitary income elasticity of demand (Ɛy = 1) In this case, increase in income is accompanied by some proportionate increase in quantity demanded. For example, 10% increase in Qd due to 10% increase in Y. Demand is unitary income elastic and the good is a normal good INCOME ELASTICITY OF DEMAND Type of Income Elasticity of Demand Low income elasticity of demand (Ɛy > 0 >1) In this case, increase in income is accompanied by less than increase in quantity demanded. For example, 5% increase in Qd due to 10% increase in Y. If the income elasticity of demand is greater than zero but less than 1, demand is income inelastic and the good is a normal good. INCOME ELASTICITY OF DEMAND Type of Income Elasticity of Demand Zero income elasticity of demand (Ɛy = 0) This shows that quantity demanded is constant regardless of changes in income. No change in Qd even 10% increase in Y. INCOME ELASTICITY OF DEMAND Type of Income Elasticity of Demand Negative income elasticity of demand (Ɛy = 0) In this case, increase in Y is accompanied by decrease in Qd. For example, 5% decrease in Qd due to 10% increase in Y. If the income elasticity of demand is less than zero (negative) the good is an inferior good. INCOME ELASTICITY OF DEMAND PRICE ELASTICITY OF SUPPLY You know that when the supply for a good increases, its equilibrium price rises and the equilibrium quantity of the good increases. But does the price rise by a large amount and the quantity increase by a little? Or does the price barely rise and the quantity increase by a large amount? The answer depends on the responsiveness of the quantity supplied of a good to a change in its price. The answer depends on the elasticity of supply of the good. PRICE ELASTICITY OF SUPPLY The price elasticity of supply is a measure of how much the quantity supplied of a good responds to a change in the price of that good. In other words, the price elasticity of supply measures the sensitivity/responsiveness of the quantity supplied due to a change in its price. Calculating the Elasticity of Supply The elasticity of supply is calculated by using the formula:  Calculating the Elasticity of Supply PRICE ELASTICITY OF SUPPLY Formula: ∆Qs / ½ (Qs1 + Qs2) ∆Py / ½ (P1 + P2) Example: P1 =RM10 Qs1 =100 P2 =RM12 Qs2 =120 Ɛs = 120-100/ ½ (100+120) =1 12-10 / ½ (10+12) PRICE ELASTICITY OF SUPPLY Degree of Elasticity PRICE ELASTICITY OF SUPPLY Degree of Elasticity PRICE ELASTICITY OF SUPPLY Degree/Types of Elasticity Because the price elasticity of supply measures how much quantity supplied responds to the price, it is closely related to the slope of the supply curve. But it is not the same thing as the slope!  Degree/Types of Elasticity PRICE ELASTICITY OF SUPPLY Elastic Supply (Ɛs > 1) The percentage change in the quantity supplied is greater than the percentage change in price (%∆Q > % ∆P) If the price elasticity of supply is greater than 1, then the good has elastic supply.  Degree/Types of Elasticity PRICE ELASTICITY OF SUPPLY Elastic Supply (Ɛs > 1) For example : Ɛs = 4. P increased by 1% lead to increase of 4% in Qs. Type of goods: production cost of this goods is small (such as books, pen, toothpaste, soap)  Degree/Types of Elasticity PRICE ELASTICITY OF SUPPLY  Degree/Types of Elasticity PRICE ELASTICITY OF SUPPLY Inelastic Supply (Ɛs < 1) The percentage change in quantity supplied is less than the percentage change in price (%∆Q < % ∆P) If the price elasticity of supply is less than 1, then the good has inelastic supply.  Degree/Types of Elasticity PRICE ELASTICITY OF SUPPLY Inelastic Supply (Ɛs < 1) For example : Ɛs = 0.5. P increased by 1% lead to increase of 0.5 % in Qs. Type of goods: production cost of this goods is high (such as computer/car)  Degree/Types of Elasticity PRICE ELASTICITY OF SUPPLY Unit Elastic Supply (Ɛs = 1) The percentage change in quantity supplied is equal to the percentage change in price (%∆Q = % ∆P) If the price elasticity of supply is 1, then the good has unit elastic supply.  Degree/Types of Elasticity PRICE ELASTICITY OF SUPPLY Perfectly Elastic Supply (Ɛs = ∞) A small percentage change in price causes an extremely large percentage change in quantity supplied. (%∆ P → ∆Qs = ∞) Quantity supplied changes infinitely with any change in price  Degree/Types of Elasticity PRICE ELASTICITY OF SUPPLY Perfectly Elastic Supply (Ɛs = ∞) Occurs when producers can offer any amount of output at the same price. Occurs when a firm can produce goods at a constant cost per unit of output  Degree/Types of Elasticity PRICE ELASTICITY OF SUPPLY Perfectly Inelastic Supply (Ɛs = 0) Quantity supplied does not change as price changes. (%∆ P → ∆Qs = 0) For example Ɛs = 0, a 1% increase in P, Qs unchanged..  Degree/Types of Elasticity PRICE ELASTICITY OF SUPPLY Perfectly Inelastic Supply (Ɛs = 0) Quantity supplied does not respond to price changes. The supply curve is vertical. Type of goods: goods to be sold immediately (that day) such as vegetables/fish.  The Determinants/Factors That Influence the Elasticity of Supply PRICE ELASTICITY OF SUPPLY The elasticity of supply for a good depends on: Time frame for supply decision Durability of the goods Cost of production Resource Substitution Possibilities Availability of stock/inventory  Time frame for supply decision PRICE ELASTICITY OF SUPPLY Time/conditions after the manufacturers market their products. The more time that passes after a price change, the greater is the elasticity of supply Elastic: Long-run supply is the most elastic. Both fixed and variable input can be changed. For example in vegetable production, Qs can be increased more in long term if new planting area (land) was found and producer can increased labor working time. PRICE ELASTICITY OF SUPPLY Time frame for supply decision Inelastic: Short-run supply is somewhat inelastic; fixed inputs (land, machinery) can not be changed, but variable input (labor time) can be changed. For example, Qs vegetables can be increased only few in short run because there was no area to plant. Perfectly inelastic Momentary supply is perfectly inelastic. In a short time (1 @ 2 days), Qs for vegetables can not be increased. PRICE ELASTICITY OF SUPPLY Durability of the goods Elastic: For durable goods, supply are more elastic. For example books. If price of books increase slightly, producer will increase Qs of the books tremendously. Inelastic: For non durable goods, supply are more inelastic. For example agricultural goods. If the price of agricultural goods increased tremendously, producer will increase Qs only slightly. PRICE ELASTICITY OF SUPPLY Cost of Production of the goods Elastic: If cost of production of a good is small, supply are more elastic. For example toothpaste. If price of toothpaste increase slightly, producer will increase Qs of the toothpaste tremendously. Inelastic: If cost of production of a good is large, supply are more inelastic. For example car. If price of cars increase tremendously, producer will increase Qs of the car only slightly. PRICE ELASTICITY OF SUPPLY Resource Substitution Possibilities The easier it is to substitute among the resources (input) used to produce a good or service, the greater is its elasticity of supply. Elastic: If input can easily replaced with another, supply are more elastic. For example shoes. If price of shoes increase slightly, producer will increase Qs of the shoes tremendously because there are a lot alternative input (rubber/canvas/plastic). Inelastic: If input cannot easily replaced with another, supply are more inelastic. For example car tires. If price of car tires increase tremendously, producer will increase Qs slightly because it is difficult to replace rubber with other inputs).  Availability of stock/inventory PRICE ELASTICITY OF SUPPLY Elastic: - If there are a lot of stock of goods, the manufacturer are able to increase their sales if the price increased. Therefore, the supply of such goods become more elastic. Inelastic: if there are only few stock of goods, the manufacturer are not able to increase their sales if the price increased. Therefore, the supply of such goods become less elastic. PRICE ELASTICITY OF SUPPLY Housing Prices and Elasticity of Supply S1 rep resents the supply of housing in city 1, and S2 represents the supply of housing in city 2. S1 has lower elasticity of supply than S2. Suppose the demand for housing in each city rises from D1 to D2. As a result, the price of houses rises in both cities, but it rises by more in city 1 than city 2. In other words, the lower the elasticity of supply, the greater the increase in price. PRICE ELASTICITY LIMITATION Aspire to Inspire before we Expire.  Happiness keeps we Sweet. Trials keep we Strong. Sorrows keep we Human. Failures keep we Humble. Success keeps we Glowing. But Only God keeps we Going.