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# The Concept of Elasticity

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### The Concept of Elasticity

1. 1. THE CONCEPT OF ELASTICITY
2. 2. THE CONCEPT OF ELASTICITY • • • • Sellers are manually expected to hope for more demand for their products Higher revenues The buyer, ever anxious in getting the best value for his money The same predicament as the seller WHAT IS ELASTICITY?  Changes in price may or may not affect the demand or supply of any good or service. A definition of elasticity is provided as follows: • It is the measure of the sensitivity or responsiveness of quantity demanded or quantity supplied to changes in prices. • The definition indicates that elasticity concerns both supply and demand.
3. 3. ELASTICITY OF DEMAND Demand elasticity indicates the extent to which changes in price or other factors cause changes in the quantity demanded. Demand elasticity may be classified as follows: 1. Price elasticity of demand 2. Income elasticity of demand 3. Cross elasticity of demand Ep = percentage change in quantity demanded Percentage change in price = QD2 – QD1 / QD1 P2 – P1/ P1 Where Ep = price elasticity of demand QD2 = new quantity demanded QD1 = original quantity demanded P2 = the new price P1 = the original price Price elasticity of Demand Price elasticity is used to determine the responsiveness of demand to changes in the price of the commodity. It may be classified with the use of formula below:
4. 4. Sample problem: Demand elasticity given as following: •Original quantity demanded = 10,000 kg Price elasticity of demand Classified. As to •Original price = P5.00 per kilo price elasticity, demand may be classified into •New quantity demanded = 16,000 kg the following types: •New price = P4.00 per kilo Answer: 16,000 – 10,000 / 10,000 = 3 Elastic Demand – is that type of demand where 1.– 5.00 / 5.00 the quantity that will be bought is affected greatly by changes in the price. The change must be greater than elasticity coefficient of 1. The demand for common luxuries (like most household appliances) and goods capable of many uses (like paper) is elastic. Inelastic demand – refers to the demand where a percentage change in price creates a lesser change in quantity demanded. An example is when a 20% reduction in price caused only a 10% increase in demand. The elasticity coefficient in this type is less than 1. The demand for necessities like food, clothing, and shelter is inelastic. Unitary demand – a change in price creates as equal change in quantity demanded. When a 20% price reduction resulted to a 20% increase in demand. The unitary demand is equal to the coefficient of 1 Semi-luxury items are goods considered with unitary elasticity. Examples are designer clothes, watches, and bath soap.
5. 5. Implications of Price Elasticity of Demand Determining demand elasticity serves a certain purpose. When elasticity is known. The seller in making decisions about price “If the price elasticity of demand is greater than one, the price should be lowered; if less than one, the price should be increased.“ Income elasticity of Demand The demand for a product or service is affected not only by its price but also by other factors like consumer income. The effect of consumer income on demand, the elasticity concept may be used. Ey = percentage change in quantity demanded Percentage change in income = QD2 – QD1 / QD1 Y2 – Y1 / Y 1 Where Ey = income elasticity of demand Y2 = the new income Y1 = the original income When elasticity is greater than 1, demand is said to be income elastic; when less than 1, it is income inelastic; and when equal to 1, it is unitary elastic.
6. 6. Cross Elasticity of Demand The demand for a certain good may be affected also by a change in the price of another good. The responsiveness of the quality demanded of a particular good to changes in the price of another good is referred to as cross elasticity of demand. The percentage change in the quantity demanded of the first good and dividing it by the percentage change in the price of the second good. Representation of this relationship is as follows: Percentage change in the quantity demanded of the first good and dividing it by the percentage change in the price of the second good. Representation of this relationship is as follows: QA2 – QA1 / QA1 If cross elasticity is positive, the goods are substitutes. An example is the 2% increase in the price of rice which causes a 0.66% increase in the demand for pan de sal. If cross elasticity is negative, the goods are complements. If tuition fee increases results to a decrease in the demand for dormitories, school dormitories are complements. Where: Ec = cross elasticity of demand QA2 = new demand for product A QA1 = original demand for product A PB2 = new price of product B PB1 = original price of product B PB2 – PB1 / PB1
7. 7. Determinants of demand Elasticity The demand elasticity of goods and services are not similar; some are elastic, and some are inelastic certain factors (or determinants). As follows: The price of the good in relation to the consumer’s budget. A change in price of cars drive consumers to think seriously about buying; while a change in the price of toothpicks (from 50 centavos per box to 75 centavos per box) are taken in stride. The availability of substitutes. The demand elasticity of a good is affected by the availability of substitutes. The more and the closer substitutes are, the more people will switch to substitutes. When the price of the good rises. The type of good. Whether it is luxury or a necessity. The demand for basic staples like rice is inelastic consumers can scarcely avoid buying them. Magazines and comics are luxuries and their demand is elastic because people can avoid buying them when their price rises. The time under consideration. If the price of rice rises, people may consider switching will be slow, however, but much can be achieved when a longer period is considered.
8. 8. ELASTICITY OF SUPPLY Elasticity of supply refers to the responsiveness of the sellers to a change in price. This may determined by computing for the percentage change in the quantity supplied of a good divided by the percentage change in the price. Determining elasticity of supply is: Es = percentage change in quantity supplied Percentage rise in the price = QS2 – QS1 / QS1 P2 – P1 / P1 Where: Es = price elasticity of supply QS2 = new quantity supplied QS1 = original quantity supplied P2 = new price P1 = original price
9. 9. ELASTICITY OF SUPPLY Elasticity of supply refers to the responsiveness of the sellers to a change in price. This may determined by computing for the percentage change in the quantity supplied of a good divided by the percentage change in the price. Determining elasticity of supply is: Es = percentage change in quantity supplied Percentage rise in the price = QS2 – QS1 / QS1 P2 – P1 / P1 Where: Es = price elasticity of supply QS2 = new quantity supplied QS1 = original quantity supplied P2 = new price P1 = original price
10. 10. Determinants of Supply Elasticity Supply is either elastic or inelastic depending on whether or not the sellers are able to respond effectively to changes in price. Supply elasticity will depend on the following factors, •The feasibility and cost of storage, if storage cost is high, even if it is available, the sellers have no choice but to sell at prevailing prices. Supply is inelastic in this case •The ability of producers to respond to price changes. If the producers can easily increase or decrease output when prices rise or fall, supply is elastic. •Time, with the passage of time, especially for long periods, supply tends to be elastic. If there is a rise in prices, the producers may not be able to make adjustments quickly, maybe able to produce more.