Elasticities of Supply and Demand

• Elasticities


  Measure to show how responsive one variable is to change in another variable
• Types of elasticities


  • Price elasticity of Demand
  • Price elasticity of Supply
  • Income elasticity of Demand
  • Cross Elasticity of Demand
• Price Elasticity of Demand (PED)


  Measures the responsiveness of quantity demanded of a good due to a change in its price, ceteris paribus
• According to the law of demand, there is an inverse relationship between price and quantity demanded of a good
• Significance of the sign of PED

  The negative sign reflects the inverse relationship between price and quantity demanded (law of demand)
• Significance of magnitude of PED

  • Signifies the sensitivity or responsiveness of quantity demanded due to a change in price
  • When demand is price inelastic, quantity demanded is not very responsive to price changes
  • When demand is price elastic, quantity demanded is very responsive to price changes
• Perfectly price elastic


  Consumers are prepared to buy all they can at the current price, P. However the smallest possible increase in price causes quantity demanded to fall to zero as consumers are extremely responsive to price increases
• Perfectly price inelastic


  Consumers prepared to pay all they can at current output. Even the largest possible change in price causes quantity demanded to remain unchanged as consumers are extremely unresponsive to price changes
• Factors affecting PED for a good


  • Number and closeness of substitutes in the same price range
  • Proportion of Income consumers spend on the good
  • Degree of necessity of the good to consumers
  • Habits of the consumers
  • Time Period
• Number and closeness of substitutes

  The larger the number of substitutes, the greater the price inelasticity of demand
• Proportion of Income spent on the good

  The higher the proportion of income spent on the good, the higher the PED, vice versa
• Degree of necessity of the good

  • The higher the degree of necessity, the lower is the price elasticity of demand
  • The lower the degree of necessity, the higher is the price elasticity of demand
• Habits of the consumers

  The greater the ability or chance of a habit formation of the good, the more price inelastic would be the demand for the good or service
• Time Period


  The longer the time period, the more price elastic the demand as consumers have more time to adjust their buying habits
• Price Elasticity of Supply (PES)


  Measures the responsiveness of quantity supplied of a good due to a change in the price of the good itself, ceteris paribus
• According to the law of supply, there is a direct relationship between price and quantity supplied
• Significance of the Sign of PES

  The positive sign reflects the direct relationship between price and quantity supplied
• Magnitude of PES


  Signifies the responsiveness of quantity supplied due to a change in quantity supplied
• Factors affecting PES for a Good or Service

  • Time Period
  • Mobility of Factors of Production
  • Spare Capacity of Firms
  • Level of Stocks and Inventories
  • Complexity of production process
• Time Period and PES

  The longer the time period, the more price elastic the supply as firms have more time to adjust their factors of production
• Income Elasticity of Demand (YED)

  Measures the responsiveness of demand for a good to a change in consumer's income, ceteris paribus
• Positive YED (normal goods)


  Income and demand change in the same direction
• Negative YED (inferior goods)


  Income and demand change in opposite directions
• Factors affecting YED of a good

  • Nature of good (Necessities vs Luxuries)
  • Level of Income
• Cross Elasticity of Demand (XED)


  Measures the responsiveness of the demand for a good due to changes in the price of another good, ceteris paribus
• Positive XED (substitutes)


  Change in price of a good results in change in demand for another good in the same direction
• Negative XED (complements)


  Change in price of a good results in change in demand for another good in opposite directions
• XED = 0 if there is no relationship between two goods
• Factors affecting XED


  • Relationship between goods