CORE-111-MODULE-5 PDF Study Guide

Commission on Higher Education CITI GLOBAL COLLEGE INC. COLLEGE OF BUSINESS AND MANAGEMENT (CBM) Bachelor of Science in Business Administration Major in Marketing Management VCB Building, Limcaoco Street, Poblacion Uno, City of Cabuyao, Laguna...

Commission on Higher Education CITI GLOBAL COLLEGE INC. COLLEGE OF BUSINESS AND MANAGEMENT (CBM) Bachelor of Science in Business Administration Major in Marketing Management VCB Building, Limcaoco Street, Poblacion Uno, City of Cabuyao, Laguna MODULE 5: ELASTICITY Elasticity is a concept in economics that measures how sensitive the quantity demanded or supplied of a good is to changes in price or other factors. It quantifies the relationship between one variable and a change in another, such as price or income. There are different types of elasticity, each focusing on different relationships, such as price elasticity of demand, income elasticity of demand, and price elasticity of supply. Importance of Elasticity: Elasticity helps businesses and policymakers understand consumer and producer behavior, set pricing strategies, and predict the effects of economic policies. For instance, governments may tax inelastic goods, like cigarettes, as demand for them will not drop significantly with price increases, ensuring steady tax revenue. Factors Influencing Elasticity:  Availability of substitutes: Goods with many substitutes tend to have more elastic demand.  Time frame: In the long run, elasticity tends to be higher because consumers and producers can adjust their behavior more easily.  Proportion of income spent: Goods that consume a large portion of income, like housing, tend to have more elastic demand. LESSON 1: PRICE ELASTICITY OF DEMAND Price Elasticity of Demand (PED) measures the responsiveness of the quantity demanded of a good to a change in its price. It tells us how much the quantity demanded changes when the price of the good changes. Understanding PED helps businesses and policymakers predict how changes in price can impact the demand for products. Formula for Price Elasticity of Demand (PED): Interpretation of PED Values:  Elastic Demand (PED > 1): When PED is greater than 1, the demand is considered elastic. This means consumers are highly responsive to price changes. A small change in price results in a larger percentage change in quantity demanded.  Example: Luxury goods like designer handbags often have elastic demand. A slight increase in price can lead to a large drop in sales, as consumers can easily forego non-essential purchases.  Inelastic Demand (PED < 1): When PED is less than 1, demand is inelastic. This means consumers are less responsive to price changes. A large change in price results in a smaller percentage change in quantity demanded. Example: Essential goods like gasoline or medications have inelastic demand. Even if prices rise, people still need to purchase these goods, so the drop in quantity demanded is small.  Unit Elastic Demand (PED = 1): When PED is exactly 1, the percentage change in price results in an exactly proportional change in quantity demanded. Example: If a 10% increase in price leads to a 10% decrease in quantity demanded, the good has unit elastic demand.  Perfectly Elastic Demand (PED = ∞): In this case, even the smallest increase in price causes the quantity demanded to drop to zero. Consumers are extremely price-sensitive. Example: Commodities with perfect substitutes, like identical brands of rice, could exhibit perfectly elastic demand if consumers immediately switch to a cheaper alternative.  Perfectly Inelastic Demand (PED = 0): Here, the quantity demanded remains constant regardless of price changes. Example: Life-saving drugs like insulin may have perfectly inelastic demand, as people need them regardless of the price. Determinants of Price Elasticity of Demand: 1. Availability of Substitutes: If there are close substitutes available, demand tends to be more elastic since consumers can easily switch to a different product if the price rises. Example: If the price of Pepsi increases, many consumers might switch to Coca-Cola, leading to more elastic demand for Pepsi. 2. Necessity vs. Luxury: Necessities generally have inelastic demand, while luxury goods tend to have elastic demand. Example: Electricity is a necessity with inelastic demand, while a vacation is a luxury with elastic demand. 3. Proportion of Income: Goods that take up a larger share of a consumer's income tend to have more elastic demand.  Example: An increase in the price of cars (which is a significant purchase) would likely lead to a substantial decrease in quantity demanded compared to a price increase in everyday items like salt. 4. Time Horizon: Demand tends to become more elastic over time because consumers can find alternatives or adjust their behavior. Example: If gas prices rise, consumers might initially continue to buy similar amounts (inelastic in the short term), but over time, they might switch to more fuel-efficient cars (more elastic in the long term). Example of Price Elasticity of Demand Calculation: Suppose the price of a product rises from $10 to $12, and as a result, the quantity demanded falls from 100 units to 80 units. The PED is calculated as: The PED of -1 (we usually express PED as an absolute value) means the demand is unit elastic, where the percentage change in price leads to an equal percentage change in quantity demanded. Applications of Price Elasticity of Demand: 1. Business Pricing Strategy: Companies can use PED to determine how a price change will affect their sales revenue. If demand is elastic, lowering the price can increase total revenue, while if demand is inelastic, raising the price can increase revenue. Example: A movie theater might lower ticket prices during weekdays when demand is elastic to attract more customers. 2. Taxation Policy: Governments often tax inelastic goods like cigarettes or gasoline because a price increase through taxation won’t significantly reduce consumption, ensuring stable tax revenues. Example: A tax on cigarettes leads to a higher price, but since demand is relatively inelastic, the reduction in cigarette consumption is small, leading to steady tax revenue. Conclusion: Price elasticity of demand is a vital concept for understanding consumer behavior, pricing strategies, and policy decisions. It reveals how sensitive consumers are to price changes and helps guide decisions in markets and industries where price and demand are tightly linked. References:  Mankiw, N. G. (2021). Principles of Economics (9th ed.). Cengage Learning.  Parkin, M. (2022). Economics (14th ed.). Pearson.  Krugman, P., & Wells, R. (2020). Microeconomics (5th ed.). Worth Publishers.  LESSON 2: PRICE ELASTICITY OF SUPPLY Price Elasticity of Supply (PES) measures how responsive the quantity supplied of a good is to changes in its price. It reflects how quickly and easily producers can adjust the quantity of a good or service they produce in response to price changes. Formula for Price Elasticity of Supply (PES): Interpretation of PES Values:  Elastic Supply (PES > 1): When PES is greater than 1, supply is considered elastic. This means that a small change in price leads to a larger percentage change in quantity supplied. Producers are able to increase output quickly in response to price increases. Example: Manufactured goods, like electronics, often have elastic supply because producers can scale up production easily with additional resources.  Inelastic Supply (PES < 1): When PES is less than 1, supply is inelastic. This means that a change in price leads to a smaller percentage change in quantity supplied. Producers struggle to increase output in response to price increases. Example: Agricultural products tend to have inelastic supply in the short run because crops need time to grow, and production can't be quickly increased.  Unit Elastic Supply (PES = 1): When PES is equal to 1, a percentage change in price leads to an equal percentage change in the quantity supplied. Example: If a 10% increase in price results in a 10% increase in quantity supplied, the good has unit elastic supply.  Perfectly Elastic Supply (PES = ∞): In this extreme case, supply is infinitely responsive to price changes, meaning that producers are willing to supply an unlimited quantity at a given price but nothing at any lower price. Example: In a perfectly competitive market, firms might supply an infinite amount at the market price, but even the smallest price decrease would lead them to stop producing altogether.  Perfectly Inelastic Supply (PES = 0): In this case, the quantity supplied remains unchanged regardless of price changes. Example: Unique, rare goods like famous paintings or limited natural resources (e.g., land in a certain location) have perfectly inelastic supply. No matter how much the price increases, the quantity remains fixed. Determinants of Price Elasticity of Supply: 1. Availability of Inputs: If inputs are readily available, supply tends to be more elastic since producers can easily scale up production. Example: The supply of cars may be elastic if raw materials like steel and labor are readily available. 2. Time Period: Supply tends to be more elastic in the long run than in the short run because firms can adjust production capacity over time. Example: Farmers cannot immediately increase the supply of wheat after a price rise, making supply inelastic in the short run. However, in the long run, they can plant more crops and increase output. 3. Spare Production Capacity: If firms have excess capacity, they can quickly increase production, making supply more elastic. Example: A factory operating at less than full capacity can increase production easily in response to price increases. 4. Storage Ability: Goods that can be stored easily tend to have more elastic supply, as firms can stockpile goods when prices are low and sell them when prices rise. Example: Durable goods like cars and electronics, which can be stored without losing value, tend to have more elastic supply than perishable goods like fruits and vegetables. 5. Flexibility of the Production Process: If a production process can be quickly adapted to produce different goods or increase output, supply will be more elastic. Example: Textile manufacturers may have elastic supply because they can switch between producing different types of garments quickly. Example of Price Elasticity of Supply Calculation: Suppose the price of a product rises from $50 to $60, and as a result, the quantity supplied increases from 200 units to 240 units. The PES can be calculated as: A PES of 1 indicates unit elastic supply, meaning the percentage change in quantity supplied is exactly proportional to the percentage change in price. Applications of Price Elasticity of Supply: 1. Business Production Decisions: Firms use PES to decide how much to increase production when prices rise. In industries with elastic supply, firms can respond quickly to price changes, while in industries with inelastic supply, production cannot be easily adjusted. Example: A car manufacturer may ramp up production when prices rise if the supply is elastic, while a farmer may not be able to do so with crops that take time to grow. 2. Government Policy: Governments consider PES when setting taxes or price controls. If supply is inelastic, producers may not be able to increase output to avoid losses when taxes are imposed. Example: A government may impose price controls on essential goods, knowing that inelastic supply will not allow firms to raise prices significantly in the short run. 3. Market Prediction: Understanding PES helps predict how quickly markets can adjust to shocks like changes in raw material prices, natural disasters, or technological advancements. Example: If a natural disaster causes a sharp increase in the price of lumber, the supply might be inelastic in the short term because it takes time to harvest and process more trees. Conclusion: Price elasticity of supply is a key concept in understanding how producers respond to price changes. It highlights the flexibility (or inflexibility) of industries in adapting to market conditions, which influences decisions in pricing, taxation, and market regulation. References:  Mankiw, N. G. (2021). Principles of Economics (9th ed.). Cengage Learning.  Parkin, M. (2022). Economics (14th ed.). Pearson.  Krugman, P., & Wells, R. (2020). Microeconomics (5th ed.). Worth Publishers.  LESSON 3: OTHER TYPES OF ELASTICITY In addition to Price Elasticity of Demand (PED) and Price Elasticity of Supply (PES), there are several other important types of elasticity that measure how different factors affect demand and supply. These include Income Elasticity of Demand, Cross Elasticity of Demand, and Advertising Elasticity of Demand. 1. Income Elasticity of Demand (YED): Income elasticity of demand measures the responsiveness of the quantity demanded for a good to a change in consumer income. It is used to determine whether a good is normal or inferior based on how demand reacts to changes in income. Formula: Interpretation:  YED > 1 (Luxury Good): Demand increases by a greater proportion than income. These goods are considered luxuries. Example: High-end electronics or luxury cars, which people buy more of as their income rises.  0 < YED < 1 (Normal Good): Demand increases less proportionally as income rises. These goods are considered normal goods. Example: Clothing and basic household items, where demand grows with income but not as much as for luxuries.  YED < 0 (Inferior Good): Demand decreases as income rises. These goods are considered inferior goods. Example: Generic brands or second-hand goods, which consumers may buy less of when their income increases and they can afford higher-quality alternatives. Applications: Income elasticity helps businesses and governments understand how economic growth or recessions may impact demand for different products. For example, during periods of rising income, businesses might expect an increase in demand for luxury goods. 2. Cross Elasticity of Demand (XED): Cross elasticity of demand measures how the quantity demanded of one good changes in response to the price change of another good. It helps determine whether goods are substitutes or complements. Formula: Interpretation:  XED > 0 (Substitutes): A positive cross elasticity means the goods are substitutes. When the price of Good B increases, the demand for Good A increases as consumers switch to the substitute. Example: If the price of tea increases, demand for coffee (a substitute) might increase.  XED < 0 (Complements): A negative cross elasticity means the goods are complements. When the price of Good B increases, the demand for Good A decreases because the two goods are often consumed together. Example: If the price of printers increases, the demand for ink cartridges (a complement) might decrease.  XED = 0 (Unrelated Goods): If XED is zero, the goods are unrelated, meaning a price change in one has no effect on the demand for the other. Applications: Cross elasticity helps businesses understand how pricing decisions for one product can impact the demand for related products. It is also useful for determining competitive strategies, such as pricing relative to substitutes. 3. Advertising Elasticity of Demand (AED): Advertising elasticity of demand measures how sensitive the quantity demanded of a product is to changes in advertising expenditure. It helps businesses understand the impact of advertising on sales. Formula: Interpretation:  AED > 0: A positive AED indicates that an increase in advertising leads to an increase in quantity demanded. Example: A significant advertising campaign for a new smartphone may result in higher sales, showing a positive AED.   AED < 0: In rare cases, an increase in advertising might lead to a decrease in quantity demanded if the advertising is poorly targeted or negatively perceived by consumers. Example: Overexposure or controversial advertisements might lead to consumer backlash and reduced demand.  AED = 0: No change in quantity demanded due to a change in advertising spending, indicating that advertising has no impact on sales. Applications: AED is crucial for businesses when allocating advertising budgets. If the AED for a product is high, a company may invest more in advertising to boost sales, but if it’s low, the company might reduce advertising spending or try different strategies. 4. Elasticity of Labor Supply: Elasticity of labor supply measures how the quantity of labor supplied responds to changes in wages. It is used to assess the flexibility of workers in adjusting their labor hours based on wage changes. Formula: Interpretation:  Elastic Labor Supply (Value > 1): Workers are highly responsive to wage changes, meaning that a small wage increase leads to a large increase in the quantity of labor supplied. Example: In some professions, such as freelance work, workers may be highly responsive to wage increases and are willing to work significantly more hours for higher wages.  Inelastic Labor Supply (Value < 1): Workers are less responsive to wage changes, meaning that even large wage increases do not significantly change the quantity of labor supplied. Example: In highly skilled or specialized professions, such as medicine or law, wage increases may not lead to significant changes in labor supply due to the long training periods required for these professions. Applications: Labor market analysis and government policies around minimum wages and tax rates can be informed by understanding the elasticity of labor supply. If labor supply is inelastic, wage increases may have little impact on the number of hours worked. 5. Elasticity of Savings: Elasticity of savings measures how responsive the amount of savings is to changes in interest rates. It is relevant for understanding how people’s saving behavior changes as the return on savings (interest rates) fluctuates. Formula: Interpretation:  High Elasticity: A significant change in the amount saved in response to changes in interest rates, often seen in economies where individuals are sensitive to saving incentives. Example: In periods of high-interest rates, people may significantly increase their savings, leading to a high elasticity of savings.  Low Elasticity: Savings change little even if interest rates rise or fall. Inelastic savings typically indicate that other factors, such as income levels, dominate savings behavior. Example: In developing economies, even if interest rates increase, savings may remain low if individuals lack sufficient income to save. Applications: Understanding savings elasticity helps in designing effective monetary policies. Central banks may use interest rate changes to influence savings and investment behavior in the economy. Conclusion: Elasticity concepts, including price elasticity, income elasticity, and cross elasticity, are essential tools for understanding the sensitivity of demand and supply to various factors. Businesses, policymakers, and economists rely on these measures to make informed decisions about pricing, advertising, production, and economic policies. Reference: Ehrenberg, R. G., & Smith, R. S. (2020). Modern Labor Economics (13th ed.). Routledge. Krugman, P., & Wells, R. (2020). Macroeconomics (5th ed.). Worth Publishers. Mankiw, N. G. (2021). Principles of Economics (9th ed.). Cengage Learning. Parkin, M. (2022). Economics (14th ed.). Pearson. Sloman, J., Garratt, D., & Wride, A. (2019). Economics (10th ed.). Pearson.