Demand and Supply Overview

Demand and Supply

Key Concepts

• Elasticity: Measures responsiveness of one variable to a change in another. Focus on demand elasticity:
  • Price Elasticity of Demand (PED): Response of quantity demanded to changes in price. Calculated as:
    PED = rac{ ext{% Change in Quantity Demanded}}{ ext{% Change in Price}}
• Ways to Measure Price Elasticity:
  1. Point Elasticity: $PED = \frac{Q_{1} - Q_{0}}{P_{1} - P_{0}} imes \frac{P_{0}}{Q_{0}}$
  2. Arc Elasticity: $PED = \frac{ ext{Average } Q}{ ext{Average } P}$

Interpretation of Elasticity Figures

• Types of demand based on PED:
  • Perfectly Inelastic (PED = 0): Demand does not respond to price change.
  • Perfectly Elastic (PED = ∞): Small price change leads to infinite change in quantity demanded.
  • Elastic (PED > 1): Larger change in quantity than price.
  • Inelastic (0 < PED < 1): Smaller change in quantity than price.
  • Unitary Elastic (PED = 1): Equal percentage change in price and quantity.

Determinants of Price Elasticity of Demand

1. Availability of substitutes.
2. Proportion of income spent on the good.
3. Time period allowed for adjustment.

Relation to Consumer Expenditure

• Total Revenue (TR): Affected by price change depending on demand elasticity:
  • Elastic Demand (PED > 1): TR decreases with price increase.
  • Inelastic Demand (PED < 1): TR increases with price increase.
  • Unitary Elastic Demand (PED = 1): TR remains constant.

Income Elasticity of Demand

• Measures responsiveness of quantity demanded to income changes.
  • Income Elasticity (IED):
    IED = rac{ ext{% Change in Quantity Demanded}}{ ext{% Change in Income}}
• Positive values: Normal goods (greater than one = luxury, less than one = necessity).
• Negative values: Inferior goods.

Cross-Price Elasticity of Demand

• Indicates responsiveness of demand for one good in response to price change of another good.
  • Positive CPED: Substitutes.
  • Negative CPED: Complements.
  • Zero CPED: Unrelated goods.