Elasticity

Elasticity

Elasticity is a measured of responsiveness of people to changes in economic variables.

Price Elasticity of Demand (Ed)

There are 3 responsiveness can be measured to price changes: elastic demand (large percentage), inelastic demand (small percentage) and unit elastic demand (equal percentage change in quantity demanded for given percentage change in price).

When calculate the Elasticity of demand, if the answer is:

< 1, the good has inelastic price elasticity of demand.

= 1, the good has unitary price elasticity of demand.

> 1, the good has elastic price elasticity of demand.

Elastic demand curve (Ed>1)

Farewell Plastic Bags

Ireland put a tax on plastic bags in 2002 and as a result, costumers have to pay 33  cents for a single bag. Only after a couple of weeks, the use of plastic bags dropped by 94 percent. It turned out people had bought re-usable bags and had been very careful to avoid plastic bags. Many people talked about how they no longer even felt comfortable buying one.

  

 

With a 94 percent drop in use we immediately can tell that plastic bags are very elastic and almost perfectly elastic. We can tell because with a minor price rise to 33 cents, the demand dropped by close to 100 percent.

Because of the elasticity of plastic bags, Ireland’s government made an effective choice. As a result Ireland has taken another small step towards defeating global warming.

Unit elastic demand (Ed=1)

If the elasticity coefficient is equal to one, demand is unitarily elastic as shown in Figure 3.  For example, a 10% quantity change divided by 10% price change is one.  This means that a one percent change in quantity occurs for every one percent change in price.

Inelastic Demand (Ed<1)

Inelastic demand is shown in above:       

Note that a change in price results in only a small change in quantity demanded.  In other words, the quantity demanded is not very responsive to changes in price.  Examples of this are necessities like food and fuel.  Consumers will not reduce their food purchases if food prices rise, although there may be shifts in the types of food they purchase. Also, consumers will not greatly change their driving behavior if gasoline prices rise.

What is the factors that affect the elasticity?

      Proportion of income

The higher the percentage of income spent, the more elastic the demand.

      Availability of Substitutes

The more substitutes the product has, the more elastic the demand.

      Luxuries versus Necessities

Luxuries tend to have an elastic demand and necessities have an inelastic demand.

      Price of the product itself

The more expensive the product, the more elastic it is.

      Habits

Habitual smokers and drinkers tend to have an inelastic demand for cigarettes and liquor respectively.

      Level of income

People with high income tend to have an elastic demand.

      Time period

The longer the time period, the more elastic the demand

Total Revenue

Total revenue (TR) is calculated by multiplying price (P) per unit and quantity (Q) of the good sold.

                                                  TR = P x Q

The total revenue test is a method of estimating the price elasticity of demand. As Ed will impact the total revenue, we can estimate the Ed by looking at the movement of the total revenue.

Total Revenue Test

Ed > 1, total revenue will decrease as price increases. P and TR moves in opposite directions. Producers can increase total revenue ( TR = Price x Quantity) by lowering the price. Therefore, most department stores will have sales to attract customers. Apparel's demand is elastic. Ed < 1, total revenue will increase as price increases. P and TR moves in the same direction. Producers can increase total revenue by raising the price. Inelastic demand for agricultural products helps to explain why bumper crops depress the prices and total revenues for farmers.

Price elasticity of supply:

The elasticity of supply measures the responsiveness of quantity supplied to a change in price of good, with all other factors remaining the same. There are three types of price elasticity of supply. The first one is market period. It is perfectly inelastic supply. The second is Short run that fixed plant size and the third one is Long run. Long run is adjustable plant size and also supply more elastic.

Elasticity of Supply = (% change in quantity supplied) / (% change in price)
As demand for a good or product increases, the price will rise and the quantity supplied will increase in response. How fast it increases depends on the elasticity of supply.
Cross Elasticity and Income Elasticity of  Demand
Cross elasticity of demand is responsiveness of quantity demanded of one good to a change in price of another good. There are three types which is the substitute goods which show the positive sign for example Coke and Pepsi. The second type is complementary goods which show the negative sign such as Car and Petrol. The independent goods is a zero cross elasticity that two product being considered are unrelated. The formula is: Exy= % change in quantity demanded of X / % change in price of Y
Income elasticity of demand measures the relationship between a change in quantity demanded for good X and a change in real income.  The formula for calculating income elasticity is: % change in demand / by the % change in income