Price Elasticity of Supply and Demand - Smart Academic Writing (2023)

Price elasticity of supply and demand

introduction

The market forces of supply and demand determine everyonebusiness operationsand the consumption of goods and services. Consumers behave in a certain way after realizing that the price of a good has changed. Some will reduce the number of units of a product they consume; Some will increase their consumption depending on price developments or changes in supply. Likewise, the operating and production conditions determine whether the producers supply the goods and services or not. The effects of taxes, improved technology, and natural disasters often impact how a product is delivered. This behavior of the two parties is examined in the price elasticity of supply and demand. This paper examines the different types of price elasticity of demand and supply, the different factors that determine elasticity, and their importance. In the investigation, the paper will first consider the price elasticity of demand and then the price elasticity of supply.

THE PRICE ELASTICITY OF DEMAND

Definition

Marshall explains that the price elasticity of demand is the responsiveness of demandRequired quantityof a product to changes in its own price. Report percent change in quantity demanded with responses to percent change in own price. In this case, other factors such as consumer income are held constant. The price elasticity of demand is always negative for a normal good, unless in the case of Veblen and Giffen goods the price elasticity is positive. The reason for this is the inverse relationship between the price of a commodity and the quantity demanded (Marshall, 2010). The formula for calculating the price elasticity of demand is given by

mi_d= % change in quantity demanded

% Price change

= ∆Q_d/ Q_d

∆P/P

Where from

q_d= quantity demanded

P = price of a good

There are shortcomings in using the above formula to calculate the price elasticity of demand. The percent change is sometimes not the same in different directions, although the magnitude of the change can be the same. For example, changing the quantity demanded from 20 to 15 and changing it from 15 to 20 units. The percentage changes are different. That is, (20-15)/20 and (15-20)/15. A solution to such scenarios involves using arc elasticity of demand and point elasticity of demand.

Arc price elasticity

In this case, two points on the demand curve (a starting point and a new point) are chosen to calculate the percentage change in price and quantity demanded. The "average" elasticity between the two points gives the elasticity. In other words, the arc formed between the two points. Mathematically,

mi_d= page₁+p₂÷ q₁+q₂ × ∆Q_d

2 2 ∆P

= page₁+p₂× ∆Q_d

q₁+q₂∆P

Where from

q₁=initial amount
q₂= end quantity
Page₁=starting price
q₂=final price

This formula assumes that the demand curve is a straight line. The greater the curvature of the demand curve, the greater the range.

“Spot” price elasticity of demand.

The point elasticity of demand accounts for infinite changes in price and quantity demanded. Integral calculus is used to calculate the elasticity. it is given as

mi_d= ∂Q_d× S

∂P Q

wo ∂Q_d= Change in quantity demanded

∂P= change in the price of a good

P = price of a good

Q= quantity demanded

Using this formula, quantity demanded is assumed to be a function of price (the demand function).

Graphic;

perfect inelastic demand

Preis

perfect elastic demand

Required quantity

Perfect elasticity of demand.
An increase in the price of a good results in a disproportionate increase in the quantity demanded. In the graphic above, it is represented with a horizontal straight line. This is from a theoretical point of view. As such, any price increase results in a decrease in the manufacturer's or price-setter's revenue. The consumer will immediately reduce his demand for the product whose price has increased. They will shift their consumption to other related products that can satisfy their utility. An example of such products is bread. In such cases, the quantity of bread demanded is relatively elastic. The price elasticity of demand is usually infinite (Marshall, 2010).

Perfect price inelasticity of demand.
Any increase in the price of a commodity results in a disproportionate increase in the quantity demanded of a product. In such circumstances, consumers have no choice in consuming a particular product and therefore will not consider it as prizes. In the graph above, perfectly inelastic demand is represented by a vertical line. Monopolies generally face such conditions as they produce unique products.

An increase in the price of a product leads to an increase in sales. This is because the revenue lost from a small reduction in quantity demanded is less than the revenue realized after the price increase. Perfectly inelastic demand usually has ami_d= 0. An example of products or services with perfectly inelastic demand is a scenario in which the consumer receives electricity as the only source of energy from a firm. Another product is sugar, which is manufactured by a single company. The only assumption under such conditions is that there is no importation of such products.

unit elasticity of demand
In this case, a product is said to have uniform elasticity of demand if a price increase does not change the quantity demanded or the change is minimal.

unit elasticity of demand

Required quantity

Unit elasticity of demand occurs when a price increase has the same effect on quantity demanded. The change (as shown in the figure above) is the same for both high and low prices.

Inelastic and elastic demand.

elastic demand

relatively inelastic demand

Preis

Required quantity

Elastic and inelastic demand occur when a change in price causes a disproportionate change in quantity demanded. Inelastic demand occurs when a change in the price of a good causes a disproportionate change in the quantity demanded. The curves of this elasticity are shown in the graph above.

Factors affecting the price elasticity of demand

The availability of substitutes determines the elasticity of a product; If the consumer can obtain other products (availability of substitute products), this means that he can easily switch his consumption from one product to another, especially when the price of a basic product increases. The more substitutes, the greater the price elasticity of supply (Marshall, 2010).

Nicholson and Snyder find that the need for a product also determines the price elasticity of demand. If the product is necessary, then its price elasticity is greater than that of products that are not necessary. Basic necessities have a high elasticity of demand compared to luxury goods. For some consumers, cars are not necessary and therefore not affected by price changes (Nicholson & Snyder, 2007).

Percentage of the buyer's budget consumed by an item; Products that consume a large portion of the buyer's budget tend to exhibit higher price elasticity. This is because the consumer may wish to satisfy their utility depending on monetary income. Items that do not consume a large portion of a consumer's budget are unaffected.

The period under consideration; over a very long period of time, the price elasticity of demand tends to be higher. This is because the consumer has time to adjust after gathering complete information about the products on the market.

The nature of a change; If prices change permanently, consumers will look for ways to change their consumption packages. Many will assume that the switch will be temporary, as it often takes some people a long time to switch their consumption from one product to another.

The price range changes; a small price increase or decrease will not have a major impact on the consumer's basket, but a large price change will. If the price of sugar falls from $2.00 to $1.99, the price elasticity of demand is less compared to a change in the same product from $2.00 to $1.50. In cases where the consumer is not the one paying for the goods, the elasticity of those goods is likely to be totally inelastic. These are scenarios in which the firm is responsible for financing its own consumption (Nicholson & Snyder, 2007).

Importance of price elasticity of demand

Many manufacturers use the concept of price elasticity of demand to make pricing decisions. Products with high price elasticity of demand; the producer does not readily raise his prices for loss of income. The manufacturer can also use the concept of price elasticity to discriminate prices in the market to maximize sales. The producer can maximize profit only when marginal revenue is zero. At this point, the price elasticity of demand should be uniform (Mankiw, 2008).

The government generally uses the concept of price elasticity to determine which goods should be taxed more heavily than others. It is very easy for the government to increase the price of cigarettes and beer without the consumer reducing the quantity demanded. It is difficult for the government to increase bread prices by taxing the product more. Consumers will consume substitutes that are cheap.

ELASTICITY OF OFFER PRICE

The price elasticity of supply is a measure of the sensitivity of the quantity supplied of a good to changes in its own price. It is also defined as a measure of the sensitivity of the delivered quantity of the good to changes in market prices. In this case, other factors such as consumer income and government taxes are assumed to remain constant (Tucker, 2008).

Mathematically,

Es = % change in amount delivered

% Price change

= ∆ Qs/Qs

∆P/P

Where from

Qs= quantity demanded

P = price of a good

For example, using the formula above, if a 10% change in price causes a 20% change in quantity supplied, then the price elasticity of supply is 2. In this case, it is positive; The reason for this is the positive relationship between price and delivered quantity. (The law of delivery).

Illustration of different price elasticities of the supply

perfect inelastic supply

perfect price inelastic supply

demand 2

demand 1

quantity delivered

From the chart above it can be seen that any price change has no effect on the quantity delivered; This is usually the case with monopolies, which prefer to put a fixed quantity of goods on the market. What happens is that the monopoly changes prices but not quantities. The consumer has limited options as the power rests with the provider. In such cases, the price inelasticity of supply is zero and is indicated by a vertical line on the chart.

perfect elastic supply

Preis

perfect elastic supply

demand 2

demand 1

quantity delivered

There are some situations where the government can regulate the prices of certain commodities to protect its citizens from exploitation by suppliers. In such cases, the suppliers supply the market with any quantity at a fixed price. These cases are common in agricultural products. The government can set a price cap for sugar. Sugar mills can sell their sugar at or below this price. The perfect price elasticity of supply is always infinite and is represented as a horizontal line. This is clearly shown in the image above.

elastic supply

Preis

elastic supply

demand2

demand 1

quantity delivered

When supply is elastic, each price increase results in a disproportionately small change in the quantity of a given good supplied to the market. For example, if the price of corn increases by 2%, the quantity supplied may increase by 1.5%;

inelastic supply

inelastic bid price

demand 2

demand 1

quantity delivered

It can happen that the supply of a certain good cannot be changed by a price change with much leeway. This concerns cases where it takes a long time to produce and bring additional goods to market to cope with rising prices (the application of the law of supply and demand to ensure that equilibrium is reached in the market). Agricultural products may be a better example of price inelasticity of supply (Nicholson & Snyder, 2007).

Unit Elasticity of Supply

Unit elasticity of supply occurs when the coefficient of elasticity is one. In such cases, a change in price causes the same change in the quantity of a product delivered. For example, if the price of coffee increases by 20%, the quantity supplied increases by the same margin.

FACTORS THAT DETERMINE THE ELASTICITY OF THE SUPPLY

The price elasticity of supply is determined by the following factors

unused capacity

According to McConnell, the availability of spare capacity determines elasticity; With a plentiful supply of available capacity, it is very easy for the supplier to increase production in a very short time, making the price elasticity of supply elastic. It can happen that the supplier runs out of raw materials, ordering such materials can take a long time and the supply is therefore inelastic (McConnell, 2005).
Shares
It is only possible to react quickly to a change in demand if the suppliers have sufficient inventories or raw materials. This makes the price elasticity of supply elastic. If the supplier does not maintain stocks on its premises (warehouses). It may take some time to produce and ensure there is enough stock to meet future demand. The amount of inventory to be held may depend on factors such as space availability and storage costs. These factors, in turn, affect the price elasticity of supply.

Simple factor substitution
The substitutability of one product factor for another determines the price elasticity of supply. When labor can be substituted for capital, the price elasticity of supply can be high. Such cases occur when labor mobility is perfect. If the factors of production cannot be exchanged for one another, the price elasticity of supply becomes inelastic.

time frame
The supply of a particular product is likely to be more elastic if the supplier takes a long time to adjust to changes in production. Agricultural goods are the best example of such goods; It takes a long time to increase agricultural production due to price increases. In this case, farmers are confronted with the lack of price elasticity of supply. Industrial goods, on the other hand, have price elasticity of supply; a very short period of time is needed to adjust the production rate to increase production to cope with rising prices (Tucker, 2008).

availability of replacement

The ease with which one product can be substituted for another determines the price elasticity of the supply. There are products that can be made in different forms. This offers suppliers the advantage of switching products with the same inputs. In this case, the price elasticity of supply is elastic. A milk processing factory can choose not to supply milk and to process butter, cheese, and powdered milk. Reducing the requested amount of milk can result in an increase in the requested amount of milk powder. College students may choose to use powdered milk over milk itself for making beverages. This gives the supplier a high level of price elasticity in the supply of milk and milk products.

Importance of price elasticity of supply

The price elasticity of supply helps the supplier know when to stock up and when not to. There is a product whose price elasticity is inelastic; The government may choose to impose taxes on this product knowing that it will not affect the quantity supplied. The government can also set maximum or minimum prices for some products, depending on their price elasticity. Agricultural products must have minimum prices, otherwise the farmers will be exploited. Likewise, finished goods must have maximum prices, otherwise the manufacturer sets its own prices. The government can use the concept of price elasticity to regulate the number of suppliers in the market (Mankiw, 2008).

Conclusion

All market participants need knowledge of the price elasticity of demand and supply to know when to buy and sell products. The government also uses this concept when identifying the types of products to be taxed. Without this concept, the government could impose very low taxes. Often the consumer bears the burden of exploitation; The government can use the concept of price elasticity of supply and demand to limit the power of suppliers to exploit consumers.

references

Mankiw G (2008). Principles of Microeconomics, Fifth Edition. Cengage Learning Publishing, New York

Tucker B. (2008). Microeconomics for Today, Sixth Edition; Überprüft. Cengage Learning Publishers, London

Nicholson W, Snyder C, (2007). Microeconomic Theory: Basic Principles and Extensions, Tenth Edition. South West Educational Publishers, Australia

Marshall A (2010). Principles of Economics: Abridged Edition Cosimo Publishers, Inc., New Jersey.

McConnell C (2005). Economics: Principles, Problems and Policies. Issue 16, McGraw-Hill/Irwin, USA.