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Demand and Supply | Elasticity | Microeconomics

Supply and Demand: Elasticity

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July 8, 2014
Marjankhan

Not only are we concerned with what direction price and quantity will move when the market changes, but we are concerned about how much they change. Elasticity is a tool to measure by how much a variable will change with there is change in another variable.

We do have such usual questions in our daily life like:

  • How much will the price of Coffee Change if Coffee beans Price rises or falls?
  • Will the Qd fall or the Qs?
  • Or Will they Both rise?
  • What if Income Increase , by how much would the demand for coffee increase?

A common definition of Elasticity is as follows:

The percentage change in one variable resulting from a one percent change (increase or Decrease)in another.

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Price, income and cross elasticity, and the revenue rule that follows from them, are covered with worked calculations in the Economics Made Simple Complete Bundle — textbook, practice questions with mark schemes, flashcards and 100 case studies.

Price Elasticity Of Demand

Measures the effect or impact of quantity demanded to price changes

In other words, It measures the percentage change in the quantity demanded of a good or commodity that results from a one percent change(increase or Decrease) in price.

image

Now Elasticity can also be written as:

image

Calculation and Interpretation

  1. Elasticity is frequently a negative number (But we use the number in Absolute Terms)
  2. As price increases, quantity decreases(Law of Demand)
  3. When |absolute value of |EP| > 1—> the good is price elastic
  4. So the effect would be —>|%change in Q| > |%Change in P|
  5. When the absolute value of  |EP| < 1—> the good is price inelastic
  6. The Effect would be —>|%change in Q| < |% change in P|

Determinants of Price Elasticity of Demand

The most important determinant of price elasticity of demand is the Availability of substitutes.

  • If there are Many substitutes than demand is price elastic
      • Can easily move to another good with price increases..This also gives a sign to competitors that with an elastic Product an increase in Price will result in lose of Consumers demanding for its product). Such products are usually household Products.
  • If there are few substitutes, demand is price inelastic.
      • You don’t have a choice but to pay high for the Same good if its Substitutes are not available. Incases like these Oil, Wheat, Sugar and other natural resources always turns out to be profitable for investors even if they increase the Price. You still have to consume it.

 

Next is Elasticity and Linear Demand Curve…..

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