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Elasticities Notes

The document provides an overview of various types of elasticities in economics, including price elasticity of demand (PED), income elasticity of demand (YED), cross elasticity of demand (XED), and price elasticity of supply (PES). It defines elastic and inelastic demand, explains how to calculate each elasticity, and discusses factors affecting them, along with their limitations. Additionally, it highlights the significance of these elasticities for businesses and governments in predicting demand and making pricing strategies.

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Aayush Dutta
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4 views

Elasticities Notes

The document provides an overview of various types of elasticities in economics, including price elasticity of demand (PED), income elasticity of demand (YED), cross elasticity of demand (XED), and price elasticity of supply (PES). It defines elastic and inelastic demand, explains how to calculate each elasticity, and discusses factors affecting them, along with their limitations. Additionally, it highlights the significance of these elasticities for businesses and governments in predicting demand and making pricing strategies.

Uploaded by

Aayush Dutta
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF, TXT or read online on Scribd
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For all elasticities related questions give examples,

define what elastic and inelastic is.

1)​Price elasticity of demand


-​ PED is the measurement of the extent to which a change in price leads to a
change in quantity demanded.
-​ PED = Percentage change in quantity demanded of a product divided by the
percentage change in price of the product.
-​ If the percentage change in quantity demanded for a product is greater than percentage
change in price of the product then PED>1(elastic)
-​ If the percentage change in quantity demanded for a product is lesser than percentage
change in price of the product then PED<1(inelastic)
-​ If the percentage change in quantity demanded for a product is equal to the percentage
change in price of the product then PED=1(Unitary)
-​ Perfectly inelastic: When a change in price of a product has no effect on the
change in quantity demanded of the product.
-​ Perfectly elastic: When a change in the price of a product causes quantity demanded
to become zero. Where all of a product is sold at a single price in the market.

-​ Factors affecting PED


●​ The availability and price of substitutes
●​ The price of the product relative to income: The proportion of income that is
spent on the good. If only a small proportion of income is spent the PED is
inelastic
●​ Loyalty: if consumers have a strong loyalty to a brand of goods, this will tend to
make PED relatively inelastic
●​ PED in the short run is inelastic, over time PED gets more elastic.
●​ Habits and addictiveness

-​
PED PED coefficient

Perfectly inelastic 0

Perfectly elastic Infinity

Unit elastic 1
-​ Limitations of PED
1.​ Does not consider the price of substitutes / complements
2.​ Does not consider the income level of the consumer
3.​ Ignores the relevance of costs. Hence, profit is uncertain.
4.​ It's an estimate so it can be inaccurate.

2)​Income elasticity of demand.

-​ YED - Is the measurement of the extent to which the change in income leads to a
change in quantity demanded of a product.
-​ Textbook definition - YED measures the responsiveness of the quantity demanded for a
product following a change in income.

-​ YED is harder to calculate than PED

-​ YED = Percentage change in quantity demanded of a good divided by the


percentage change in income.

-​ Classification of goods in relation to YED


- Normal goods = YED is between 0 and 1
- Inferior goods = YED < 0 (negative)
- Necessity goods = YED is close to or equal to 0
- Superior or luxury goods(A type of normal good) = YED > 1
-​ YED helps governments and firms predict the demand for goods and services in the
future. Basically helps improve efficiency in allocating resources in the future.
-​ YED also helps producers decide which goods to produce during recession and
which goods to produce when there is economic growth(it affects the income of
the consumers) , using the values of YED.
-​ A necessity good for one consumer could be a normal good for a better-off consumer.

3)​Cross elasticity of demand

-​ XED is the measurement of the extent to which the change in price of one good
leads to a change in quantity demanded for another good.
-​ XED = Percentage change in quantity demanded for good ‘A’ divided by the
percentage change in price of good ‘B’.

-​ XED can be negative or positive.


-​ When XED is positive, the two goods are substitute goods and have an alternate
demand. This is because an increase in price of one good causes an increase in
quantity demanded for the other good.
-​ When XED is negative, the two goods are complements and have a joint demand. This
is because an increase in price of one good will cause a decrease in quantity demanded
for the other good.
-​ When XED is 0 the two goods are unrelated to each other.
-​ limitations of using XED e.g., other factors may have a greater influence e.g.,
brand loyalty to a competitor.

-​ The closer the relationship between two products, whether substitutes or


complements, the greater the magnitude of the value of XED.
-​ XED helps firms come up with pricing strategies.

-​
4)​Price elasticity of supply

-​ PES is the percentage change in the quantity supplied of a product divided by the
percentage change in the price of a product.
-​ In general PES in the short run is inelastic as firms take longer to respond to changes
in market prices, however in the long run PES is more elastic as firms respond faster to
changes in market prices.
-​ If the percentage change in quantity supplied for a product is greater than percentage
change in price of the product then PES>1(elastic)
-​ If the percentage change in quantity supplied for a product is lesser than percentage
change in price of the product then PES<1(inelastic)
-​ If the percentage change in quantity supplied for a product is equal to the percentage
change in price of the product then PES=1(Unitary)

-​ Factors affecting PES


1.​ (Spare) Productive capacity of the firms
2.​ Excess Stocks - The greater the ease of storing stocks the more elastic the
supply will be. Perishable goods such as agricultural goods may be harder
to store. However, manufactured goods are easier to store as they are less
perishable.
3.​ Time period - if more firms join the industry over time, PES will be relatively
elastic
4.​ Time needed to produce the good - the shorter the time, the more elastic
supply will be
5.​ State of technology
6.​ The number of producers/Firms in the market.
7.​ Factor mobility - the easier it is to move resources into the production of
particular goods, the more elastic PES will be.

-​ Limitations of PES
1.​ Ignores the practical ability to increase the PES - for example in agriculture.
2.​ To make a product more elastic, more money is required. Hence this can reduce
profit in the short run.

-​ Benefits of PES
1.​ The potential to invest in productive spare capacity can be used if demand rises
by: increasing overtime payments to workers, and outsourcing from other firms
producing similar goods.

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