All about elasticity

1.  Elasticity
 Means “Responsiveness”.
 It isthe ratioof the percentchange inanothervariable.
 It isa tool usedbyeconomistsformeasuringthe reactionof afunctiontochangesin
parametersina relative way.
 Demand Elasticity
 Is a measure of the degree of responsivenessof quantitydemandedof aproductto a
givenchange inone of the independentvariableswhichaffectdemandforthatproduct.
 Classificationofdemand elasticityaccording to factors that cause the change:
 Price elasticityof demand
 Is the responsivenessof consumers’demandtochange inprice of the good sold.
 Income elasticityof demand
 Is the responsivenessof the consumers’demandtoa change intheirincome.
 Cross elasticityof demand
 Is the responsivenessof demandforacertaingood,in relationtochangesin
price of otherrelatedgoods’.
 DEMAND ELASTICITY
 Referstothe reactionor response of the buyerstochangesin price of goodsand services.
5 TYPES OF DEMAND ELASTICITY
 ELASTIC DEMAND
 A change inprice resultsto a greaterchange inquantitydemanded.
 INELASTICDEMAND
 A change inprice resultsto a lesserchange inquantitydemanded.
 UNITARY DEMAND
 A change inprice resultsto an equal change inquantitydemanded.
 PERFECTLY ELASTIC
 Withoutchange inprice,there isinfinite change inquantitydemanded.

2.  PERFECTLY INELASTIC
 A change in price createsnochange inquantitydemanded.
DETERMINANTS OF DEMAND ELASTICITY
 NUMBER OF GOOD SUBSTITUTE
 many substitute- elastic
 Withoutsubstitute-inelastic
 PRICE INCREASEIN PROPORTION TOINCOME
 Verylittle effect- inelastic
 Involvessubstantial amount- elastic
 IMPORTANCEOF THE PRODUCT TO THE CONSUMERS
 Notimportant- elastic
 Important- inelastic
Elasticity ofsupply
 Referstothe reactionor response of the sellers/producerstoprice change of goods.
2 Important Factors of SupplyElasticity:
a. Time
b. Time horizoninvolvedwithwhichproductioncanbe increased.
c. Time
d. Time horizoninvolvedwithwhichproductioncanbe increased.
THEORY OF CONSUMERBEHAVIOR
 Law of diminishingmarginal utility
 Utility-satisfaction
 Marginal utilityreferstothe additional satisfactionof aconsumerwheneverhe
consumesone more unitof the same good.
Production
 Is the creationof goodsand servicestosatisfyhumanwants.

3.  Kindsof goods
 Economicgoods
 Free goods
Factors of productionare called inputs of production.
Goodsand servicesthathave beencreatedbythe inputsare called outputs of production.
The processof transformingbothfixedandvariableinputsintofinishedgoodsandservicesiscalled
theory of production.
The technical relationshipbetweenthe applicationof inputs(factorsof production) andthe resulting
maximumobtainableoutputisknownas production function.
LAW OF DIMINISHING RETURNS
 Alsoknownaslaw of diminishingmarginal productivity.
 It statesthat whensuccessive unitsof variable input(like farmers) workwithafixedinput(like
one hectare of land),beyondacertainpointthe additional product(output) producedbyeach
additional unitof variable,inputdecreases.
Message of the Law
Marginal product isdefinedasthe additional productbroughtaboutbyone additional unitof a
variable input(farmer).
Whenmarginal productincreases,total productalsoincreases.Whenmarginal product
decreases,total productincreasesata decreasingrate,andwhenmarginal productisbelow
zeroor negative,total productfalls.
There isa propercombinationof avariable inputintoafixedinputinordertoattainthe
maximumoutput.
It isnot advisable tokeeponincreasingthe numberof farmerstowork inone hectare of rice
field.If theyare many,mostof themhave nothingto do.Theyonlyhamperthe worksof the
otherfarmers.
A goodknowledge of factorproportioncontributestoprofitmaximization orproduction
efficiency.
ECOOMIC COST
 Total Cost- sumtotal cost of production

4.  FixedCost- costwhichremainsconstantregardlessof the volumeof production
 Variable Cost- changesinproportiontovolume of production
 Average Cost- unitcost
 AC= TC
Q
 Marginal Cost- additional orextracost broughtaboutby producingone additional unit.
 MC= ∆ TC = TC2-TC1
∆Q Q2-Q1
 ExplicitCost- expenditure cost
-costspaidin cash
 ImplicitCost- non-expenditure cost
- imputedcostof self-ownedorself employedresourcesbasedontheiropportunitycosts.
 Opportunitycost- aforegone opportunityoralternative benefit.
- the economiccost of an inputusedina productionprocessisthe value of
outputsacrificedelsewhere. The opportunitycostof aninputis the value of
foregone income inbestalternativeemployment.
 WhenMC isfalling,itpullsdownAC,andwhenMCis rising,itpullsupAC.MC intersectsACat
itslowestportion.
 Short run- referstoa periodof time whichistooshortto allow an enterprise tochange itsplant
capacity,yetlongenoughto allow achange in itsvariable resources.
 Long run- refersto a periodof time whichislongenoughtopermita firmor enterprise toalter
all itsresourcesor inputs(bothfixedandvariablefactors).

5.  External economiesof scale- referstothose factorswhichare outside the firmorenterprise,but
theycontribute tothe efficiencyof the latterintermsof increasedoutputanddecreasedunit
cost of production.
 Governmentpolicies,electrification,transportationandcommunicationfacilities
 Internal economiesof scale- these are the factorsinside the firmorenterprise whichcontribute
to the efficiencyof the latter.
 Divisionof labor,humanresourcesdevelopment,managerialspecialization,properuse
of machinesandequipment,favorable managementpolicies,effectiveutilizationof by-
products,and moderntechniquesof production.
Appropriate Techniquesof Production
 Labor- intensive technology- more laborinputsandlesscapital inputs.
 Capital-intensive technology –more capital inputsandlesslaborinputs.