The market

Interpreting elasticity of demand

Elasticity of demand refers to how responsive consumers are to changes in the price of a product.

Price elasticity of demand:

PED = percentage change in quantity demanded/ percentage change in price

If PED is greater than 1 demand is said to be elastic. Buyers are more responsive to price changes. For PED less than 1 demand is deemed inelastic. Buyers are not greatly affected by price changes, they will continue to buy similar quantities. When PED equals 1 demand is unit elastic. Percentage change in price matches the percentage change in demand. Perfectly elastic demand occurs when any increase in price causes demand to drop to 0. Perfectly inelastic demand occurs when demand remains constant regardless of changes in price. Products and services considered as necessities typically have inelastic demand as consumers will continue to buy them despite price alterations. Luxury items and those with close substitutes tend to have elastic demand since consumers are able to change their buying habits in response to price changes. High elasticity indicates that price changes could significantly impact revenue. Low elasticity suggests price changes will not greatly influence consumer behaviour. In short term, consumers may not easily change their buying behaviour due to prices so demand appears inelastic. However in the long term customers could find alternatives or adjust their habits making demand seem more elastic. Availability of substitutes, the degree of necessity, the cost relative to income and timeframe are factors that can influence the elasticity of a product or service. Potential inaccuracies in measuring changes and the assumption that other things remain equal when calculating elasticity must be considered.

Supply and demand

The relationship between supply and demand influences price and quantity of goods and services. Demand is the quantity of a good or service consumers are willing and able to buy at a specific price. It can be influenced by price, income, tastes and expectations of future price changes. Supply refers to the quantity of a good or service producers are willing and able to offer for sale at a certain price. It can be influenced by the price of a good or service, technology advancements, input costs and government policy. The law of demand states: as the price of a good or service increases consumer demand decreases, when the price decreases consumer demand increases. This creates a downward slope on a demand curve. The law of supply states: as the price of a good or service increases the quantity of goods a supplier is willing to offer also increases. This results in an upward sloping supply curve. Market equilibrium occurs when the quantity demanded equals the quantity supplied. The equilibrium price and quantity represents a balance between consumer preferences and producers preferences. Price elasticity of demand measures the responsiveness of quantity demanded to changes in price. It’s categorised as elastic, inelastic and unitary elastic. Price elasticity of supply measures the responsiveness of quantity supplied to changes in price. If the response is high, supply is said to be elastic. Low responsiveness leads to inelastic supply. Shifts in demand and supply curves can occur due to non-price factors. Demand factors could be changes in income levels, tastes or preferences. Supply factors could be technology advancements or changes in production costs. Understanding comparative statistics can help decipher shifts in market conditions. If demand increases more than supply this will raise the equilibrium price and vice versa. Government price floor and ceiling policies can establish minimum or maximum prices while taxes and subsides can change the cost of production and consumption. Businesses and policymakers use these principles to make informed decisions about pricing, production levels and policy approaches. A solid understanding of supply and development fundamentals aids in making accurate predictions about market behaviour.