(Microeconomics)
Elasticity is the measure of how consumers respond to changes in price
The main and basic rule of elasticity is that a price change leads to a large change in quantity demanded, which is relative to the price change
Formula:
The point of using this formula is to find the type of elasticity, which is represented by values.
^^Type of Elasticity^^ | ^^Elasticity Value^^ |
---|---|
Perfectly Inelastic | = 0 |
Unit Elastic | = 1 |
Relatively Inelastic | < 1 |
Relatively Elastic | > 1 |
Perfectly Elastic | Infinity |
}}Tips for finding the elasticity value:}}
Now we know how to find the value of elasticity, however, what is the purpose of understanding elasticity?
^^Types of Elasticity^^ | ^^Relationship between Price and Total Revenue^^ |
---|---|
>1, Relatively elastic | P and TR are inversely related |
<1, Relatively inelastic | P and TR have a direct relationship |
= 1, Unit elastic | TR does not change when P does |
}}Tips:}}
As a %%general rule,%% it is helpful to think of the top portion of the demand curve as the elastic range, and the lower section to be the inelastic range
As price decreases in the inelastic range, the total revenue falls. We can see this being applied in monopoly as well, as a monopoly is produced in the elastic range of the demand curve
%%How to determine Demand Elasticity?%%
This measures how the changes in price of a certain good can affect the quantity demanded of another product. The result of this calculation is to find out if product are complementary or substitute goods. If the result is positive, the two goods are substitutes, if the result is negative, the goods are complements
Substitute goods are those which can be exchanged with one another. For example, different brands of bread are substitute goods as they provide the same product which can be interchanged with another.
Complementary goods are those with complement each other. For example, gas and cars are complementary, as we cannot use one without the other.
Formula: CPED = % change in QD of Product X / % change in Price of Product Y
QD is divided by Price. A negative output means that the goods are complementary, while a Positive output means that the goods are substitutes
The price elasticity of supply takes into the consideration how a change in price affects the quantity supplied. (Elasticity values are the same as those of demand).
The longer firms have to adjust, the more elastic their supply curve will be. This leads to difficulty for many firms to increase production of goods in the short term.
In the long run, a market or industry supply curve is usually perfectly elastic. This is relevant when studying perfect competition.
In Fig.2, the perfectly inelastic supply conveys that a change in price leaves the quantity supplied unchanged, whereas the perfectly elastic supply will remain unchanged and unaffected by changes in price.
^^Consumer surplus^^ is the difference between the highest price a consumer would pay for a product minus the actual price paid. This surplus is calculated in order to measure the social benefits of public goods. On a graph, Consumer surplus can be located below the demand curve , above price, and left of quantity.
When consumer and producer surpluses are maximised, the economy will experience efficiency and therefore lead to equity.
When the prices of goods or services lead to inequality and inefficiency in the market, the government has to intervene and set policies to fix this. Some producers set prices in a way which only acts in their self interest.
A ^^price ceiling^^ is a maximum legal price that can be charged for a product or service. Price ceiling is exactly as the name suggests, it is the maximum price which can be set on any goods or services. This allows for more equity in the market, as well as sets a clear equilibrium for producers to maintain. The limit may displease producers, which leads them to convert their policies to ones which will eventually benefit the market.
\n
On the other hand, any price set under the ceiling will create a shortage as the quantity demanded will exceed the quantity supplied. In some cases, the price ceiling will not fix disequilibrium.
A price Floor is a minimum legal that can be charged for a product or service. This policy is set when the government believes that producers are not receiving enough income. For example, the government can set price floors to support farmers and adjust minimum wage.
}}Tip: Remember that a price ceiling is only valid if it is placed below the equilibrium price, otherwise, it will not be effective. A price floor will only be functional if it is place above the equilibrium price.}}
When a market fails to maximise total surplus, a deadweight loss is created. (total surplus is the sum of consumer and producer surpluses)
^^Deadweight loss^^ is the loss of total surplus when a market fails to reach a competitive equilibrium.
@@Deadweight loss with a Price Floor@@
A maximum price is set above the competitive market price. The deadweight loss here is the difference between values of units which are not traded. This is basically the leftover goods and services which have not purchased in the market
This is a cost to society which is created by market inefficiency, and it occurs when supply and demand are out of equilibrium
@@Impact of Taxes on Consumer and Producer Surpluses@@
^^Elasticities^^ | ^^Who will Pay the Tax?^^ |
---|---|
Elasticity of Demand > Elasticity of Supply | Producers will pay more tax than consumers |
Elasticity of Demand < Elasticity of Supply | Consumers pay more tax than producers |
Perfectly Inelastic Demand (Ed=0) | Consumers pay all the tax |
Perfectly elastic demand (Ed=infinity) | Consumers pay none of the tax |
Perfectly inelastic supply (Es=0) | Producers pay all of the tax |
Perfectly elastic supply (Es=Infinity) | Producers pay none of the tax |
All taxes create a deadweight loss. A tariff is a tax on imports or exports, and a quota has a similar effect on trade that sets a limit on the quantity of goods imported and exported. After the tariff, the quantity of imports decreases, and areas where consumer surplus before trade are now tax revenue from the tariff and deadweight loss
^^Using the Utility- maximisation rule^^ | ^^Using the Utility- maximisation rule^^ |
---|---|
If MU/Px > MU/Py | Buy more of x and less of y |
if MU/Px < MU/Py | Buy more of y and less of x |
if MU/Px = MU/Py | Maintain current consumption level |