Concept of Elasticity - Economics


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Concept of Elasticity - Economics

  1. 1. Obillo, Nichole Beatrize V. January 3, 2013A-203/A206B Prof. Hazam E. Bansa ECONOMICSAssignment: (Chapter 4 Summary “Concept of Elasticity”) In Economics, the concept of elasticity measures the responsiveness of one variable to a certainchange of another variable. There are two significant words: measure, reported as numbers or coefficients andresponsiveness, which means reaction to change.Formula used to determine elasticity is:Elasticity, therefore, is the percentage change in one variable in relation to the percentage change in anothervariable.Elasticity can be applied to demand in order to measure its responsiveness to the changes on its selecteddeterminants.The price elasticity of demand measures the responsiveness of the quantity demanded with respect to itsprice. The basic formula used to calculate the coefficient of price elasticity of demand is:Price elasticity of demand is the percentage change in quantity demanded that occurs with respect to apercentage change in price.Degree of Price Elasticity of Demand. Price elasticity of demand is categorized depending upon the responseof quantity demanded to a change in price as follows: 1) Elastic Demand. Demand is price elastic when elasticity coefficient is greater than one. 2) Inelastic Demand. Demand is price inelastic when elasticity coefficient is less than one. 3) Unitary Elastic Demand. Demand is unitary elastic when elasticity coefficient is equal to 1.Extreme Cases of Price Elasticity of Demand>Perfectly Elastic Demand- when demand is totally responsive to changes in price.>Perfectly Inelastic Demand- when quantity demanded totally does not respond to any changes in price.Determinants of Price Elasticity of Demand 1) The importance or degree of necessity of the goods. The more essential or necessary the goods or services, the more inelastic the demand. 2) Number of available substitutes. Demands for goods with greater number of substitutes are elastic, while goods with less or no substitute have inelastic demand. 3) The proportion of income in price changes. Demand is inelastic for a product whose changes in price seemingly have no effect on the consumer income or budget. 4) The time period. The longer the time period, the less elastic or more inelastic the demand will be.Effect on Total Revenue>The price effect. This refers to an increase in price that will result to a positive effect on revenue, and viceversa.>The quantity effect. This pertains to an increase in price that will lead to less quantity sold, and vice versa.
  2. 2. Income Elasticity of DemandThe responsiveness of quantity demanded in response to a change in income is known as the income elasticityof demand. This measures the percentage change in demand over the percentage change in income. Basically,formula for income elasticity demand is:A good is considered as a normal good when its income elasticity is positive. As income increases, more goodsand services will be demanded. A good is said to be an inferior good when its elasticity income is negative. Asincome rises, quantity demands for such goods declines.Cross Price Elasticity of DemandThe cross price elasticity of demand measures the responsiveness of quantity demanded of a good to achange in the price of another good. Formula in computing cross elasticity:Cross price elasticity of demand simply measures whether the good is a substitute or a complementary.Complementary goods are goods that are used in conjunction with other goods.Supply ElasticityPrice Elasticity of SupplyThe concept of price elasticity of supply measures the responsiveness of quantity supplied in response to apercentage change in the price of the goods. The formula of price elasticity of supply is identical:Degree of Price Elasticity of Supply 1) Elastic Supply- a change in price leads to a greater change in quantity supplied. 2) Inelastic Supply- a change in price leads to a lesser change in quantity supplied. 3) Unitary Elastic Supply- a change in price leads to an equal change in quantity supplied.Extreme Cases of Price Elasticity of Supply 1) Perfectly Elastic Supply- This occurs when there is no change in price, and there is an infinite change in quantity supplied. 2) Perfectly Inelastic Supply- This happens when a change in price has no effect on quantity supplied.Determinants of Price Elasticity of SupplyThe primary determinant of price elasticity of supply is the time period involved. A noted economist, AlfredMarshall distinguished the time period of supply as follows: 1) Monetary or Intermediate. In this period, supply will be perfectly inelastic and the supply is fixed. 2) Short-run. In this state, supply is inelastic. The output of production can increase even if equipment is fixed. 3) Long-run. In this period, supply is elastic. New firms are expected to enter or the old one may leave the industry.