ELASTICITY OF DEMAND SUPPLY Learning Objectives At the

ELASTICITY OF DEMAND & SUPPLY

Learning Objectives At the end of the session, participants should be able to: Knowledge q Define price elasticity of demand. q Define price elasticity of supply. q Define income elasticity.

Learning Objectives Performance q Calculate elasticity values Attitude q. Appreciate the importance of the elasticity concepts.

Previous Knowledge Required previous knowledge: • Demand supply • Law of demand • Law of supply

Price Elasticity of DD The degree of responsiveness of quantity demanded of a commodity to the change in price is called elasticity of demand. Elasticity of demand expresses the magnitude of change in quantity of a commodity.

Types of elasticity Five cases of Elasticity of Demand: • Elastic demand • Inelastic demand • Perfectly inelastic demand • Unitary elastic demand

Elastic demand % change in price causes a greater % change in quantity demanded. If price changes by 10% the quantity demanded of the commodity change by more than 10% i. e. 25%.

Inelastic demand % change in price causes less % change in quantity demanded. If price falls by 20% quantity demanded rises by less than 20%.

Unitary demand % change in price causes an equal % change in quantity demanded. If the price falls by 25% the quantity demanded rises by the same 25%. Numerically elasticity of demand is said to be equal to 1. (ed = 1).

Perfectly elastic A very insignificant change in price leads to an infinite change in quantity demanded. A very small fall in price causes demand to rise infinitely. Similarly, a very insignificant rise in price reduces the demand to zero.

Perfectly inelastic A change in price produces no change in the quantity demanded of a commodity. Thus the amount demanded will be totally unresponsive of change in price. Therefore, elasticity of demand is said to be zero.

The determinants of Ed • Substitution effect Demand is more elastic for a good with close substitutes. When consumers have limited alternatives, the demand for a good is more price inelastic.

The determinants contd. • Income effect If the share of budget spent on a good is very small, the demand for the good will be inelastic.

The determinants contd. • Luxury Vs Necessity: Necessity's demand is usually inelastic because there are usually very few substitutes for necessities. Luxury product, such as leisure sail boats, are not needed in a daily bases. There are usually many substitutes for these products. So their demand is more elastic.

The determinants contd. • Time lag effect: The longer the time after the price change, the more elastic will be the demand. It is because consumers are given more time to find more substitutes.

Elasticity of Supply Price elasticity of supply measures how responsive producers are to a change in the price of good. It is defined as a measure of the responsiveness of quantity supplied to change in price.

Types of elasticity of sup • • • Elastic supply Inelastic supply Perfectly inelastic supply Unitary elastic supply

Determinants of Es • Availability of materials: The limited availability of raw materials could limit the amount of a product that can be produced.

Determinants of Es cont. • Length and complexity of product: If the product is complex to manufacture, it becomes more inelastic. • Time to respond: If the producer has more time to respond to price changes, the product is more elastic.

Determinants of Es cont. • Excess capacity: A producer with unused capacity will quickly respond to price changes • Inventories : A producer with a large number of products can quickly increase the amount of supply it delivers to the market.

Determinants of Es cont. • The number of substitutes: This determines how easily one person could switch from one product to another and determines how elastic or inelastic a good is.

Income elasticity This measures the percentage change in the quantity demanded of a good to a given percentage change in income.

Income Elasticity contd. Inferior Goods with an income elasticity less than one are called inferior goods. Demand for such goods decreases as income increases.

Income Elasticity contd. Normal Goods with income elasticity greater than zero are called normal goods. Demand for such goods increases as income increases

Income Elasticity contd. Normal goods with an income elasticity less than one are income inelastic. Necessities such as food, housing, and clothing are good examples.

Income Elasticity Goods with income elasticity greater than one are income elastic. Luxuries such as fine cars, vintage wine, and meals at fancy restaurants are examples.

Cross Price Elasticity This measures the responsiveness of the demand for one good to changes in the price of another good. It is the percentage change in the demand of one good (holding the price constant) divided by the percentage change in the price of another good.

Cross Price Elasticity contd. The numerical value can be positive, negative, or zero depending n whether the two goods are substitutes, complements, or unrelated.

Cross Price Elasticity contd. Substitutes If an increase in the price of one good leads to an increase in the demand for another good, the value of their cross price elasticity is positive and the goods are substitutes.

Cross Price Elasticity contd. Complements If an increase in the price of one good leads to an decrease in the demand for another good, the value of their cross price elasticity is negative and the goods are complements.

Cross Price Elasticity Independent Goods Independent goods have a cross-price elasticity of zero: as the price of one good increases, the demand for the second good is unchanged.

Recap Questions • • Define price elasticity of demand. Define price elasticity of supply. Define income elasticity. Explain the importance of elasticity concepts.