Chapter 5 - Elasticity of Demand and Supply

The price elasticity of demand measures the percentage change in quantity demanded divided by the percentage change in price, or:

• Price elasticity of demand = percentage change in quantity demanded/percentage change in price

Elasticity describes the connection between two quantities: the percentage change in the quantity requested and the percentage change in price. We don't need to worry about how production or pricing is measured because the emphasis is on the percentage change. That is all.

What is important is the percentage change in the amount requested. It also makes no difference whether the price can be expressed in US dollars, Mexican pesos, Zambian kwachas, or Vietnamese dong. The only thing that matters is the percentage change in price.

Finally, according to the rule of demand, price and quantity requested are inversely related. Because price and amount wanted are linked, price changes and quantity requested changes move in opposite directions.

Knowledge of price elasticity of demand is especially valuable to producers because it indicates the effect of a price change on total revenue. Total revenue (TR) is the price

• (p) multiplied by the quantity demanded (q) at that price or TR =  p x q.

The aggregate outcome of these opposing impacts determines the overall impact of a reduced price on total revenue. If the positive effect of increased demand outweighs the negative effect of reduced pricing, overall revenue rises. More specifically, if demand is elastic, the percentage increase in the amount demanded surpasses the percentage rise in quantity demanded.

As a result of the percentage drop in price, overall income rises. If demand is elastic on a unit basis, the percentage increase in the quantity requested is exactly equivalent to the percentage drop in price.

As a result, overall income stays constant. Finally, if demand is inelastic, the beneficial impact is magnified. The effect of an increase in the quantity requested on total income is more than compensated.

The long-run price elasticity of demand is higher because customers have more time to adjust. For example, if the price of energy rises today, customers may reduce their usage of electrical equipment in the near run, and those who have electric heat may lower the thermostat in the winter.

Consumers, on the other hand, would gradually convert to more energy-efficient equipment, improve house insulation, and maybe abandon electric heat. As a result, long-run demand for power is more elastic than short-run demand. In reality, demand is more elastic in the long run in any case when estimates for both the short and long runs are known.

• The term price elasticity of demand measures how responsive quantity demanded is to a price change; the percentage change in quantity demanded divided by the percentage change in price

• The term price elasticity formula Refers to the Percentage change in quantity demanded divided by the percentage change in price; the average quantity and the average price are used as bases for computing percentage changes in quantity and in price

Prices communicate to both sides of the market the relative scarcity of items. Higher costs discourage consumption while stimulating production. Lower prices promote consumption while discouraging output. Price elasticity of demand assesses how sensitive customers are to price changes. Similarly, supply price elasticity determines how sensitive producers are to price changes. The supply elasticity is computed.

In the same way that demand elasticity exists. Simply put, supply price elasticity is a measure of the price elasticity of supply = the percentage change in supply divided by the percentage change in demand price. Because a higher price typically leads to an increase in quantity delivered, the percentage change is significant.

The elasticity formula for the supply curve can be calculated using the following:

• Es = Δq/(q + q’)/2 ÷ Δp/(p + p’)/2

• Where Δq is the change in quantity supplied and Δp is the change in price.

This is the same formula used to calculate the price elasticity of demand, except that q here refers to the amount provided rather than the quantity demanded. Supply elasticity is referred to in the same way as demand elasticity: Supply is inelastic if its elasticity is less than 1.0; unit elastic if it equals 1.0, and elastic if it surpasses 1.0.

The elasticity of supply measures how sensitive producers are to price changes.

Their reaction is determined by how simple it is to adjust the quantity given when the price changes. If the cost of delivering more units skyrockets as output grows, then a greater price generates a minimal increase in the amount provided, implying that supply is inelastic. However, if the marginal cost rises gradually as output expands, the allure of a higher price fades causing a significant rise in the quantity delivered. Supply is more elastic in this scenario.

The duration of the adjustment phase is one factor of supply elasticity consideration. Similarly, when customers adjust to new conditions, demand becomes more elastic over time.

• The term income elasticity of demand refers to the percentage change in demand divided by the percentage change in consumer income; the value is positive for normal goods and negative for inferior goods

The capacity to expand supply in reaction to a higher price varies by industry. For example, oil was discovered on Alaska's north slope in 1967, but it took another decade for oil to flow south. Generally speaking, the response time is slower for oil, power, and timber providers (where expansion may take years, if at all, not decades) than vendors of window-washing services, lawn upkeep, and other such services, where vending of hot dogs (where expansion may take only days)