Daffodil International University

Faculties and Departments => Business and Economics => Business Administration => Topic started by: Raisa on February 02, 2018, 07:14:55 PM

Title: Elasticity
Post by: Raisa on February 02, 2018, 07:14:55 PM

Elasticity of Demand and Supply

Elasticity is the ratio which measures the responsive or sensitiveness of a dependable variable to the change in any of the independable variables. If Y=f(X), i.e., Y depends on X, then the elasticity of Y with respect of X is:

Elasticity = Percentage change in dependable variable / Percentage change in independable variable

Elasticity of Demand:  The elasticity of demand is the measure of responsiveness of demand for a commodity to the changes in any of its determinants. The determinants are the commodity’s own price, income, price of related goods (substitutes and complements), and consumers expectations regarding future price.

The elasticity of demand can be calculated with respect to each of the determinants.

Price Elasticity of Demand: If the price of a commodity changes, then do consumers change their attitude in buying that commodity? The answer may be one of the following?

•   They do not change their attitude;
•   They slightly change their attitude;
•   They change their attitude drastically.

How much consumers respond to the price changes is measured by price elasticity of demand. In other words, the response of consumers to a change in price is measured by the price elasticity of demand. Specially, the price elasticity of demand refers to the percentage change in quantity.   

Price elasticity of demand = Percentage change in quantity demand rate / Percentage change in price.

Determinants of Price Elasticity of Demand: The price elasticity of demand is influenced by all the determinants of demand. The following determinants are worth noting:

Nature of the Goods (Luxuries versus Necessities): Necessities such as food stuff are price inelastic, means they are not very responsive to change in price because people do not reduce their consumption of price even if the price is very high. People can not live without food. There, rise in price cannot influence the demand for necessities very much. On the other hand, goo such as air conditioner, decoration items, etc. are price elastic, means they are very responsive to changes in prices. People can postpone the consumption of luxury goods when their prices rise.

Availability of Close Substitutes: If consumers can easily get a good substitute Y for a product X, they will switch readily to Y if the rice of X rises. For example, if the price of Close-UP toothpaste rises, people will switch readily to any other brands such as Pepsodent, Colgate, etc. On the other hand if the substitutes of any commodity are not easily available the elasticity will be low, like the elasticity of demand for personal computer.

Fraction of the Income Absorbed: If only a small fraction on income is spent on a good, then a change in its price has little impact on the consumer’s overall budget. In contrast, even a small rise in the price of a good that commands a large part of a consumer’s budget induces the consumer to make a radical reappraisal of expenditures. For example, we can think about the elasticity of demand for textbooks and chewing gum. If price of textbooks doubles, there will be a big decrease in the quantity of textbooks bought. Thus students will share and photocopy the textbooks instead of buying new ones. If the chewing gum doubles also, there will be no change in the quantity of gum demanded. The difference is because books take a large proportion of the budget, while gum takes only a tiny portion.

Time: The demand for many products is more elastic in the long run than in the short run. Consumers may not immediately reduce their purchases very much when the price of chicken rises 10%, but in time they may shift to beef or fish. Therefore, since consumers do not reduce the demand for a commodity immediately after the rise in its price, the demand for that commodity is inelastic in the short run. But if the price of the chicken remains high for a long time, then consumers switch to any convenient or less costly substitutes for chicken, which make the demand for chicken elastic in the long run.

Alternative Uses of a Commodity: The more the uses of a commodity, the highly elastic is the demand for it. For example, if the price of milk falls, the demand of milk will increase more than the proportionate fall in its price, because milk can be used in different purposes such as in making curds, ghees, butter, sweets, etc. Therefore, the demand for milk is highly elastic.

Elasticity of Supply: The elasticity of supply measures the response of quantity supplied to the changes in any of its determinants.

Price Elasticity of Supply: The price elasticity of supply measures the responsiveness of the quantity supplied of a commodity to a change in its price. The formula used to calculate the price elasticity of supply:               

Price elasticity of supply = Percentage change in quantity supplied / Percentage change in price.

Cross Elasticity: In cross elasticity, we examine the effect of the percentage change in the quantity demand rate for one product with respect to percentage change in the price of another product. For example, Econo Ball Pen and Writer Ball Pen have a high cross elasticity of demand. The producer of Econo Ball Pen is thus in competition with the producer of Writer Ball Pen. If  the If the Econo Ball Pen company rises its price, it will lose substantial sales to the Writer Ball Pen producer.

Income Elasticity of Demand: Income elasticity of demand is defined as the ratio of percentage change in quantity demand rate with respect to percentage change in income. 

Income Elasticity of Demand = Percentage change in quantity demand rate / Percentage change in income.

Elasticity of Demand Analysis:

If Ed = 0; the product is perfectly inelastic, which means that when prices of such products change, there is absolutely no reaction among the consumers. Example, very luxury products.

If Ed < 1; the product is highly inelastic, which means that when prices of such products change, there is almost no or very little reaction among the consumers. Example, nearly luxury products.

If Ed = 1; the product is perfectly elastic, which means that when prices of such products change, there will 100% reaction among the consumers. Example, very essential products.

If Ed > 1; the product is highly elastic, which means that when prices of such products change, there will be huge reaction among the consumers. Example, nearly essential products.