Elasticity and Its Applications

Price Elasticity of Demand and Supply

• Definition of Elasticity: Elasticity measures how much customers and suppliers respond to changes in prices.

  • Formula: \text{Elasticity} = \frac{\text{Percentage change in quantity}}{\text{Percentage change in price}}

  • Types of Elasticity:

    • Elastic (Elasticity > 1)

    • Unit Elastic (Elasticity = 1)

    • Inelastic (0 < Elasticity < 1)

The Elasticity of Demand

• Price Elasticity of Demand (PED): It measures how much the quantity demanded (QD) responds to a change in price (P).

  • Formula: \text{Price Elasticity of Demand} = \frac{\text{Percentage change in QD}}{\text{Percentage change in P}}

  • Example: ( \text{PED} = \frac{15\%}{10\%} = 1.5 ) (Demand is elastic)

Calculating Percentage Changes

• Standard Method:

  • \text{Percentage change} = \frac{\text{End Value} - \text{Start Value}}{\text{Start Value}} \times 100\%

• Example Calculation:

  • Price changes from P6.00 to P10.00; QD changes from 120 to 80:

    • Percentage change in P: \frac{10 - 6}{6} \approx 66.67\%

    • Percentage change in Q: \frac{80 - 120}{120} \approx -33.33\%

    • Using Standard Method: \text{Elasticity} = \frac{33.33}{66.67} \approx 0.5

    • When reversing the calculation gives a different elasticity of 1.25.

• Midpoint Method:

  • Formula: \text{Percentage change} = \frac{\text{End Value} - \text{Start Value}}{\text{Midpoint}} \times 100\%

  • Example from earlier case using midpoint method results in a more consistent elasticity of 0.8.

Types of Demand Elasticity

• Perfectly Inelastic: Demand does not change regardless of price ( \text{Elasticity} = 0 ).

• Inelastic: Demand changes little with price change (0 < Elasticity < 1).

• Unit Elastic: Demand changes exactly as price (Elasticity = 1).

• Elastic: Demand changes significantly with price changes (Elasticity > 1).

• Perfectly Elastic: Demand changes infinitely with any price change ( \text{Elasticity} = \infty ).

Determinants of Demand Elasticity

1. Availability of Substitutes: More substitutes lead to more elastic demand.

2. Necessities vs. Luxuries: Necessities tend to be inelastic, while luxuries are more elastic.

3. Definition of the Market: Narrowly defined markets have more elastic demand.

4. Time Horizon: Demand tends to be more elastic over longer time periods.

The Elasticity of Supply

• Price Elasticity of Supply (PES): It measures how much the quantity supplied (QS) responds to a change in price (P).

  • Formula: \text{Price Elasticity of Supply} = \frac{\text{Percentage change in QS}}{\text{Percentage change in P}}

Types of Supply Elasticity

• Perfectly Inelastic: Supply does not change regardless of price ( \text{Elasticity} = 0 ).

• Inelastic: Supply changes little with price change (0 < Elasticity < 1).

• Unit Elastic: Supply changes exactly as price (Elasticity = 1).

• Elastic: Supply changes significantly with price changes (Elasticity > 1).

• Perfectly Elastic: Supply changes infinitely with any price change ( \text{Elasticity} = \infty ).

Determinants of Supply Elasticity

• Ability of sellers to change the quantity produced—more flexible production means greater elasticity.

• Long-run elasticity often greater as firms can adjust resources and capacity compared to short-run.

Applications of Elasticity in Economics

• Total Revenue and Price Elasticity:

  • Analyzes how price changes affect total revenue and helps businesses strategically adjust prices.

  • If demand is elastic, increasing prices could reduce total revenue due to a drop in quantity sold.

  • Conversely, if demand is inelastic, businesses can raise prices without significantly impacting total revenue.

• Taxation Impact: Understanding elasticity helps analyze who bears the burden of taxes.

• Price Controls: Elasticity assesses effects of price controls and their implications in real markets.

Key Takeaways

• Elasticities indicate buyer and seller responsiveness to price changes and have critical implications for pricing, taxation, and resource allocation decisions in economics.

• Elasticity types are vital for understanding behavior but depend on market conditions, product characteristics, and time frames.