Elasticities in Economics PDF

BASIC ECONOMICS Module __ Topic: ELASTICITIES Objectives: 1. Understand and Define Different Types of Elasticities 2. Calculate and Interpret Elasticities 3. Analyze Factors Influencing Elasticities: 4. Apply Elasticity Concepts to Decision-Making:...

BASIC ECONOMICS Module __ Topic: ELASTICITIES Objectives: 1. Understand and Define Different Types of Elasticities 2. Calculate and Interpret Elasticities 3. Analyze Factors Influencing Elasticities: 4. Apply Elasticity Concepts to Decision-Making: 5. Evaluate the Impact of Elasticity on Economic Outcomes: ============================================================================== ELASTICITY - Elasticity in economics refers to the responsiveness of one variable to changes in another variable. It's a measure that helps us understand how much a change in one factor (like price) will affect another factor (like quantity demanded or supplied) PRICE ELASTICITY OF DEMAND Price elasticity of demand (PED) measures how sensitive the quantity demanded of a good or service is to a change in its price. Several factors influence the price elasticity of demand: Types of Elasticity/Interpretation: Elastic Demand (PED > 1): A small change in price leads to a relatively large change in quantity demanded. Goods like luxury items often have elastic demand. Inelastic Demand (PED < 1): A change in price leads to a relatively small change in quantity demanded. Necessities like food and gasoline typically have inelastic demand. Unitary Elastic Demand (PED = 1): A change in price leads to a proportional change in quantity demanded. Perfectly Elastic Demand (PED) =∞ (infinity): Perfectly elastic demand occurs when the quantity demanded responds infinitely to even a very small change in price. This means  that if the price changes by any amount (no matter how small), the quantity demanded will drop to zero or become infinite. Perfectly Inelastic Demand (PED = 0): Perfectly inelastic demand occurs when the quantity demanded does not change at all, regardless of changes in price. This means that consumers will buy the same amount no matter how much the price increases or decreases. Factors that Influence PEoD 1. Availability of Substitutes 2. Necessity vs. Luxury 3. Proportion of Income Spent on the Good 4. Time Horizon 5. Brand Loyalty 6. Who pays 7. Habitual Consumption 8. Durability of the Good 9. Addictive Properties 10. Advertising and Marketing How to COMPUTE PEoD Example: Using MidPoint Formula 1. A farmer sells banana at a local market. If the price of bananas increases from PHP 80.00 per kilo to PHP 90.50 per kilo, the quantity demanded for the farmer's bananas decreases from 100 kilos to 10 kilos. Calculate the elasticity of demand for the farmer's bananas. 2. A life-saving medication is available in limited supply. Regardless of the price, consumers will purchase 100 units of the medication. If the price of the medication increases from PHP 5,500 per unit to PHP 11,000 per unit, calculate the elasticity of demand for this medication. 3. The price of a popular brand of sneakers increases from PHP 5,500 to PHP 6,600. As a result, sales of the sneakers decrease from 1000 pairs to 800 pairs. Calculate the elasticity of demand for these sneakers. 4. The price of gasoline increases from PHP 165 per gallon to PHP 198 per gallon. Despite the higher price, consumers only reduce their gasoline consumption from 100 gallons to 95 gallons. Calculate the elasticity of demand for gasoline. 5. The price of a certain brand of coffee increases from PHP 137.50 per cup to PHP 165 per cup. As a result, sales of the coffee decrease from 200 cups to 150 cups. Calculate the elasticity of demand for this coffee. PRICE ELASTICITY OF SUPPLY Price Elasticity of Supply measures how much the quantity supplied of a good changes in response to a change in its price. Types and Interpretation: Elastic Supply (PES > 1): Suppliers can increase production significantly when prices rise. Inelastic Supply (PES < 1): Suppliers cannot easily increase production, even if prices rise. Unitary Elastic Supply (PES = 1): The percentage change in quantity supplied equals the percentage change in price. Perfectly elastic supply (PES= ∞ (infinity) occurs when producers are willing to supply any quantity of a good at a specific price, but none at all if the price drops even slightly. Perfectly inelastic supply (PES =0) occurs when the quantity supplied is fixed, regardless of the price. Suppliers will provide the same quantity no matter how high or low the price goes. Factors that influence PEoS 1. Time Period 2. Availability of Inputs 3. Production Capacity 4. Stock Levels and Inventory 5. Production Lag 6. Availability of Substitutes in Production 7. Barriers to Entry and Exit 8. Nature of the Good FORMULA FOR CO MPUTING PEoS (please follow the midpoint formula of PEoD) Point of Reference Price Supply A 120 200 B 100 175 C 80 160 D 85 100 E 60 50 Compute the following combination using the midpoint formula 1. A to B 2. C to D 3. E to D 4. C to B INCOME ELASTICITY OF DEMAND Income Elasticity of Demand measures how much the quantity demanded of a good changes in response to a change in consumers' income. Interpretation: Normal Goods (YED > 0) As income increases, demand for these goods also increases. Inferior Goods (YED < 0) As income increases, demand for these goods decreases. Luxury Goods (YED > 1) Demand increases more than proportionally as income increases. The factors that influence income elasticity of demand (YED) include: 1. Nature of the Good (Normal/Necessities vs. Luxuries) 2. Income Level of Consumers 3. Availability of Substitutes 4. Consumer Preferences 5. Proportion of Income Spent on the Good: 6. Time Horizon: 7. Economic Conditions: Follow the Midpoint Formula; replace price with income. Imagine that you manage a store that sells two types of products: Product A and Product B (a. Last year, your customers had an average income of Php50,000, and this year, their average income increased to Php60,000. During this period: The quantity demanded for Product A increased from 500 units to 700 units. The quantity demanded for Product B increased from 1,000 units to 1,050 units. Objective: Calculate the income elasticity of demand (YED) for both Product A and Product B, and interpret the results. Cross Elasticity of Demand (XED) Cross Elasticity of Demand measures how much the quantity demanded of one good changes in response to a change in the price of another good. Interpretation: Substitutes (XED > 0)-An increase in the price of one good leads to an increase in the demand for a substitute good. Complements (XED < 0)- An increase in the price of one good leads to a decrease in the demand for a complementary good. Unrelated Goods (XED = 0) The price change in one good does not affect the demand for another.  Suppose you manage a grocery store, and you are analyzing the relationship between two products: Product X (butter) and Product Y (margarine). You observed the following changes: The price of Product X (butter) increased from php22.00 to php23.00 per unit. As a result, the quantity demanded for Product Y (margarine) increased from 1,000 units to 1,200 units. Objective: Calculate the cross-price elasticity of demand (XED) between butter (Product X) and margarine (Product Y), and interpret the result using MIDPOINT formula. ============================================================================= Prepared by: IMELDA A. SIAPNO Faculty In-charge