Price elasticity of supply and demand
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
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
mid= % change in quantity demanded
% Price change
= ∆Qd/ Qd
qd= 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,
mid= page1+p2÷ q1+q2 × ∆Qd
2 2 ∆P
= page1+p2× ∆Qd
q2= end quantity
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
mid= ∂Qd× S
wo ∂Qd= 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).
perfect inelastic demand
perfect elastic demand
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 amid= 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
Price of the rectangular hyperbola
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.
relatively inelastic demand
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).
Es = % change in amount delivered
% Price change
= ∆ Qs/Qs
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
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
perfect elastic supply
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.
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 bid price
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
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).
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.
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).
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.
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.
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How will you describe price elasticity of demand and supply? ›
The price elasticity of demand is the percentage change in the quantity demanded of a good or service divided by the percentage change in the price. The price elasticity of supply is the percentage change in quantity supplied divided by the percentage change in price.What is price elasticity of supply essay? ›
Price elasticity of supply (PES) measures the relationship between change in quantity supplied and a change in price. If supply is elastic, producers can increase output without a rise in cost or a time delay. If supply is inelastic, firms find it hard to change production in a given time period.What is price elasticity of demand essay? ›
The price elasticity of demand for a good is a measure of the degree of responsiveness of the quantity demanded to a change in the price, ceteris paribus. The demand for private cars is likely to be price elastic due to the large proportion of income spent on the good as private cars are generally expensive.What are the 4 determinants of price elasticity of supply? ›
Determinants of Elasticity of Supply
Effortlessness of switching. Ease of storage. Length of the period of production. The time frame of training.
Price elasticity of supply is defined as the percentage change in quantity supplied caused by a given percentage change in own price of the commodity. It is measured as the ratio between the percentage change in quantity supplied and the percentage change in the price of the commodity.What is the importance of price elasticity of demand and supply? ›
Price Elasticity of Demand is a factor that determines the change in consumption or demand of a service or product when its price is changed. This concept holds importance for economists as they gauge the supply and demand for a product when its price changes.What is the purpose of elasticity of supply? ›
The price elasticity of supply measures the responsiveness of quantity supplied to changes in price. It is the percentage change in quantity supplied divided by the percentage change in price.What is the price elasticity of demand for dummies? ›
Price elasticity of demand is the ratio of the percentage change in quantity demanded of a product to the percentage change in price. Economists employ it to understand how supply and demand change when a product's price changes.What is price elasticity of demand thesis? ›
An increase in price leads to a decrease in quantity demanded, and a decrease in price leads to an increase in quantities demanded. Their demands are dependent on each other. The degree to which a commodity responds to a change in price is called price elasticity of demand.What is price elasticity of demand with examples? ›
Elastic demand is used to describe the scenario where the change in demand is sensitive to a small change in price. For example, if we see a large change in the price of Lays chips, consumers are more likely to shift to a different brand, driving the demand down and vice versa.
What are the 2 types of price elasticity of supply? ›
Price elasticity of supply is of 5 types; perfectly elastic, more than unit elastic, unit elastic supply, less than unit elastic, and perfectly inelastic.What reduces price elasticity of supply? ›
Technology innovation can reduce supply elasticity. More efficient production reduces costs and allows for expanded production. If supply is elastic, so is price. A greater supply of a product or service reduces its cost.What are the 3 cases of supply elasticity? ›
The elasticity of supply is very important when it comes to demand shifts in the market. That is because it determines by how much the price and quantity of the good will change. The types of elasticity of supply are perfectly elastic, elastic, unit elastic, inelastic, and perfectly inelastic supply.What is an example of price elasticity of supply in real life? ›
An example of an elastic supply is the supply of non-necessity goods such as soft drinks where there are many substitutes and choices. A drastic change in price will not have a toll on the supply since consumers would opt for other brands of soft drinks or prefer close substitutes.What is the price elasticity of supply can you give an example in your own words? ›
Price elasticity of supply measures the responsiveness of quantity supplied to a change in price. The price elasticity of supply (PES) is measured by % change in Q.S divided by % change in price. If the price of a cappuccino increases by 10%, and the supply increases by 20%. We say the PES is 2.0.What is the conclusion for elasticity of supply? ›
Conclusion. We can define price elasticity of supply as the responsiveness of the quantity of goods supplied to the changes in price. It is the ratio of the percentage change in the quantity of supplied goods to the percentage change in the price of goods.How does price elasticity of demand impact pricing decisions? ›
Using Elasticity for Pricing Decisions
For elastic products, reduce prices to drive more sales volume. This will also improve your price perception in the market. With inelastic products, increase your prices to drive higher margins with limited impact on units sold.
The four factors that affect price elasticity of demand are (1) availability of substitutes, (2) if the good is a luxury or a necessity, (3) the proportion of income spent on the good, and (4) how much time has elapsed since the time the price changed.How does elasticity of demand affect economy? ›
A good that has a high demand elasticity for an economic variable means that consumer demand for that good is more responsive to changes in the variable. Conversely, a good with low demand elasticity means that regardless of changes in an economic variable, consumers don't adjust their spending patterns.What factors affect elasticity of supply? ›
There are numerous factors that impact the price elasticity of supply including the number of producers, spare capacity, ease of switching, ease of storage, length of production period, time period of training, factor mobility, and how costs react.
What is the main factor that affects elasticity of supply? ›
As with demand elasticity, the most important determinant of elasticity of supply is the availability of substitutes. In the context of supply, substitute goods are those to which factors of production can most easily be transferred.How important is elasticity in our daily lives? ›
Elasticity plays a very important role in daily life in designing a structure which undergoes different types of stress. Some of the examples are: In order to calculate the elastic limit of metallic machineries so they cannot be subjected above a particular level of stress.What is elasticity very short answer? ›
elasticity, ability of a deformed material body to return to its original shape and size when the forces causing the deformation are removed. A body with this ability is said to behave (or respond) elastically.What is elasticity of demand very short answer? ›
The elasticity of demand refers to the degree to which demand responds to a change in an economic factor. Price is the most common economic factor used when determining elasticity. Other factors include income level and substitute availability. Elasticity measures how demand shifts when economic factors change.What is the principle of theory of elasticity? ›
In the science of physics, elasticity is the ability of a deformable body (e.g., steel, aluminum, rubber, wood, crystals, etc.) to resist a distorting effect and to return to its original size and shape when that influence or force is removed. Solid bodies will deform when satisfying forces are applied to them.How would you describe supply elasticity or elasticity of supply? ›
The price elasticity of supply is a measure of how sensitive the quantity supplied of a good is to changes in price. It is calculated as the percentage change in quantity supplied divided by the percentage change in price.How do you describe elasticity of demand? ›
The elasticity of demand refers to the degree to which demand responds to a change in an economic factor. Price is the most common economic factor used when determining elasticity. Other factors include income level and substitute availability. Elasticity measures how demand shifts when economic factors change.How would you describe supply and demand? ›
Supply refers to the market's ability to produce a good or service, whereas demand refers to the market's desire to purchase the good or service. Supply and demand is often considered to be a fundamental concept within economics and is primarily used to describe the price and availability of commodities.How do you explain supply and demand? ›
Supply is generally considered to slope upward: as the price rises, suppliers are willing to produce more. Demand is generally considered to slope downward: at higher prices, consumers buy less.What is the conclusion of elasticity of supply? ›
Conclusion. We can define price elasticity of supply as the responsiveness of the quantity of goods supplied to the changes in price. It is the ratio of the percentage change in the quantity of supplied goods to the percentage change in the price of goods.
How does elasticity of demand affect the economy? ›
A good that has a high demand elasticity for an economic variable means that consumer demand for that good is more responsive to changes in the variable. Conversely, a good with low demand elasticity means that regardless of changes in an economic variable, consumers don't adjust their spending patterns.What factors affect elasticity of demand? ›
Many factors determine the demand elasticity for a product, including price levels, the type of product or service, income levels, and the availability of any potential substitutes. High-priced products often are highly elastic because, if prices fall, consumers are likely to buy at a lower price.What is the importance of elasticity in economics? ›
Elasticity is an important economic measure, particularly for the sellers of goods or services, because it indicates how much of a good or service buyers consume when the price changes. When a product is elastic, a change in price quickly results in a change in the quantity demanded.How does supply and demand affect the economy? ›
It's a fundamental economic principle that when supply exceeds demand for a good or service, prices fall. When demand exceeds supply, prices tend to rise. There is an inverse relationship between the supply and prices of goods and services when demand is unchanged.What are the 4 basic laws of supply and demand? ›
1) If the supply increases and demand stays the same, the price will go down. 2) If the supply decreases and demand stays the same, the price will go up. 3) If the supply stays the same and demand increases, the price will go up. 4) If the supply stays the same and demand decreases, the price will go down.What is the law of supply and demand for dummies? ›
The law of supply states that the quantity of a good supplied (i.e., the amount owners or producers offer for sale) rises as the market price rises, and falls as the price falls. Conversely, the law of demand (see demand) says that the quantity of a good demanded falls as the price rises, and vice versa.What is supply and demand in economics essay? ›
The law of supply and demand combines two fundamental economic principles describing how changes in the price of a resource, commodity, or product affect its supply and demand. As the price increases, supply rises while demand declines. Conversely, as the price drops supply constricts while demand grows.