Post on 14-Dec-2015
description
Elasticity of Demand And Supply
Elasticity of Demand And Supply
• Response of the buyers and sellers to a change in price.
• Both sellers and buyers react to a change in price.
• Such reactions vary depending on the importance of the products and their ability to produce in a given time.
Elasticity of Demand• Elasticity of Demand
Refers to the reaction or response of the buyers to change in price of goods and services.
However this reaction vary in accordance with the nature of the product, if it is important or not to the consumers.
Types of Demand Elasticity1. Elastic – A change in
price results to a greater change in quantity demanded.
Example: a 20% increase in price lead to a 60% increase or decrease in quantity demanded. This shows buyers are very sensitive to price change. They are discourage to buy the product when price increases and encouraged to buy more when price decreases.
Types of Demand Elasticity2. Inelastic demand –
A change in price results to a lesser change in quantity demanded.
For example a 50% change in price creates only a 5% change in quantity demanded. This means buyers are not sensitive to price change.
Types of Demand Elasticity
Products under this category are essential to the buyers. However, a big decrease in the prices of the afforementioned goods has a very little effect on quantity demanded
Types of Demand Elasticity
3. Unitary Demand – A change in price results to equal change in quantity demanded.
For example a 25% increase in price produces a 25% change in quantity demanded
Types of Demand Elasticity
4. Perfectly elastic demand
Without change in price, there is an infinite change in quantity demanded.
Types of Demand Elasticity5. Perfectly Inelastic
demand – A change in price creates no change in quantity demanded.
This applies to products without substitutes and this is a situation which involves life and death to an individual.
Types of demand elasticity
Determinants of Demand Elasticity
1. Number of Good substitute – Demand is elastic for products with many good substitute.
An increase in the price of such product induces buyers to look for good substitute. On the other hand, product without good substitute have an inelastic demand. Buyers have no or little choice except to purchase them.
Determinants of Demand Elasticity
2. Price increase in proportion to income
If the price increase has very little effect on income or budget of the buyers, demand is inelastic. But if the price increase involves a substantial amount in proportion to the income of consumers, demand is elastic.
Determinants of Demand Elasticity
3. Importance of the product to the consumer – Luxury goods are not that important to the people, so, these have elastic demand. However products which are essential to the people like rice, water and power supply have inelastic demand.
ELASTICITY FORMULA
• Elasticity =
Q
Q
P
P
Q = the difference between the original quantity and the new quantity (disregard the negative sign
Q
= the difference between the original price and the new price (disregard the negative sign)
P
P
= the original quantity
= the original price
ELASTICITY FORMULA• Example
• Solution
• If Elasticity coefficient (answer) is:• More than 1= elastic demand/supply• 1=unitary elastic• Less than 1= inelastic demand/supply
YEAR QUANTITY DEMANDED
PRICE
1988 100 4
1989 60 5
Q = 40
Q= 100
P
P
= 1
= 4
Economic Significance of Demand Elasticity
1. A good knowledge of demand elasticity helps the businessmen in planning their pricing strategies.
2. In the case of the government, it guides the economic managers in formulating appropriate tax programs.
3. The market price of products influence wages, rents, and profits.
Practical Examples:
1. Wage determination – If the product has an elastic demand, a reduction in its price increases quantity demanded. This means more sales and profits for the company. The company now is in the position to raise the wages of its workers.
2. Farm production guide – Producers must be careful in overproducing goods whose demand is inelastic, like agricultural products because prices of these products decrease which will affect in turn the income of the farmers.
Practical Examples:
3. Maximize profits – A reduction in price causes more quantity demanded. Businessmen can estimate how far they can cut their prices to be able to generate their target sales. Evidently a substantial price reduction favors goods with highly elastic demand.
Practical Examples:
4. Imposition of sales taxes
Government officials should exercise prudence in taxing goods and services. Otherwise instead of getting more money from the people, they get less. It is not advisable to increase taxes on goods with elastic demand.
• Mr. Pedro, a farmer, notices that the price of potatoes increases. However, he is still sad because he can’t produce more upon knowing such great news. Why?
• Mr. Garcia invested his money in acquiring a land. He did not have any intention of selling it for 20 years. Why?
Thought Experiments•?
ELASTICITY OF SUPPLY
•At the end of this lecture, you should know the ff:
1. Elasticity of Supply2. Input Prices 3.Determinants of Elasticity of Supply4. Consumer Behavior
• Elasticity of Supply• - the measure of responsiveness in Quantity supplied (Qs) • to a change in price (P); Degree of producers' sensitivity to • price
Elasticity of Supply• Supply elasticity –
refers to the reaction of the sellers or producers to change in the price of goods. However such response of the sellers vary in accordance with the kind of goods they produce.
Types of Elasticity of Supply
1. Elastic – A change in price (increase or decrease) results to a greater change in quantity supplied. This means producers and sellers are very responsive to change
2. Inelastic – A change in price results to a lesser change in quantity supplied. This shows that producers and sellers have very weak response to price change. With a high price, they like to increase their quantity supplied, but they cannot do it at once.
Types of Elasticity of Supply
Types of Elasticity of Supply3. Unitary – A change in
price results to an equal change in quantity supplied. This is a border line case between elastic and inelastic supply. Examples of these goods must be those that are classified as semi-industrial or semi- agricultural product.
4. Perfectly elastic – Without change in price, there is an infinite (without limit) change in quantity supplied. Example of this is a situation in a poor country with an unlimited number of jobless individuals who are willing to work.
Types of Elasticity of Supply
Types of Elasticity of Supply5. Perfectly inelastic – A
change in price has no effect on quantity supplied. Land is an example of this coomodity. Land area is fixed regardless of price. The increase in population has tremendously increased the price of land.
Determinant of Supply Elasticity
• TIME – is the only determinant of supply elasticity. It depends on how the producers and sellers could respond immediately to a change in price.
Supply Elasticity Graphs
S
S
S
ELASTICITY FORMULA
• Elasticity =
Q
Q
P
P
Q = the difference between the original quantity and the new quantity (disregard the negative sign
Q
= the difference between the original price and the new price (disregard the negative sign)
P
P
= the original quantity
= the original price
ELASTICITY FORMULA• Example
• Solution
• If Elasticity coefficient (answer) is:• More than 1= elastic demand/supply• 1=unitary elastic• Less than 1= inelastic demand/supply
YEAR QUANTITY DEMANDED
PRICE
1988 100 4
1989 60 5
Q = 40
Q= 100
P
P
= 1
= 4
• Why is Maria not happy after riding the rollercoaster for the 10th time today?
• Can you happily consume your favorite ice cream in one hour or one day and receive the same satisfaction of eating one cone of ice cream?
Thought Experiments•?
Theory of Consumer Behavior
1. Law of Diminishing Returns or Marginal Productivity
2. Indifference Curve
3. Budget Line
Law Of Diminishing Returns or Marginal Utility
• Utility means satisfaction• Marginal utility refers to the
additional satisfaction whenever a consumer consumes one more unit of the same good. Consumption of more successive units of the same goods increases total utility but at a decreasing rate because marginal utility diminishes.
PERSONDOGROSE
•2 BOTTLES
OF WATER
1 2
3
Total utility increases at a decreasing rate due to a diminishing marginal utility
Quantity of a good
Consumed
Total Utility Marginal Utility
1 5
2 9 4
3 12 3
4 14 2
5 15 1
6 15 0
MARKET STRATEGY
Indifference Curve
• The word “indifference” means showing no bias or neutral.
• An indifference curve is a curve which shows different combinations of two goods which yield the same level of satisfaction.
• Good X
• Good Y
1
2
3
1 2 30
• 0
• 0
• 0
• Coke or Pepsi• I don’t care whether you have Coke or Pepsi, as
long as it is cola.
• I like apples and bananas. If you cut the number of apples in half and double the number of bananas, I am just as well off.
• Lenovo or Acer
An Indifference schedule showing the various combinations of meat and fish
Combinations Kilos of Meat Kilos of Fish
A 5 1
B 4 2
C 3 3
D 2 4
E 1 5
“An indifference map is composed of a series of
indifference curves. Each curve to the right of another provides greater satisfaction because its
constitutes combinations of more units (or kilos) of two products (meat and fish)”
Budget Line or Consumption Possibility Line
• This indicates the various combinations of two products which can be purchased by the consumer with his income, given the prices of the product A B Expenditures Total
1 2 3 4 1
5 4 3 2 5
25 + 125 50 + 100 75 + 75 100 + 50 25 + 125
150150150150150
A budget line schedule showing the various combination of two products with a fixed budget of
P150 and the unit price of both products at 25.
Units of product A
Units of product B
Total Expenditures
5 1 P125+ P25= P1504 2 P100+ P50= P1503 3 P75+P75= P1502 4 P50+P100= P1501 5 P25+P125=P150
Equilibrium of the Consumer• Equilibrium of the
consumer showing B as the combination of two goods which provide maximum satisfaction to the consumer. This is also the point where the budget line is tangent to the indifference curve.
Good X
• Good Y
• A
• C
• B
• D