Elasticity of Demand and Supply notes-CSEET
Elasticity of Demand and Supply:
ICSI CSEET: The Council of the ICSI has released a notice regarding CSEET on the day of the inauguration of ICSI Golden Jubilee Celebrations on 4th Oct 2017.
The Gazette Notification on the Company Secretaries (Amendment) Regulations, 2020 has been published on 3rd February 2020 in the Official Gazette of India and the same shall be applicable from the said date of publication.
Now ICSI Published a notice regarding CSEET Test which going to start from 2020 May.
We are now going to discuss the details of CSEET Paper-3 Economics and Business Environment notes – Elasticity of Demand and Supply.
Elasticity of Demand and Supply:
ELASTICITY OF DEMAND
In economics, the demand elasticity (elasticity of demand) refers to how sensitive the demand for a good is to changes in other economic variables, such as prices and consumer income.
Demand elasticity is calculated as the percent change in the quantity demanded divided by a percent change in another economic variable. A higher demand elasticity for an economic variable means that consumers are more responsive to changes in this variable.
“Elasticity of demand is the responsiveness of the quantity demanded of a commodity to changes in one of the variables on which demand depends. In other words, it is the percentage change in quantity demanded divided by the percentage in one of the variables on which demand depends/’ The variables on which demand can depend on are:
- Price of commodity
- consumer’s income etc.
There are major three types of elasticity of demand, i.e. Price elasticity, Income elasticity and Cross elasticity. However, this lesson focuses only on price elasticity of demand.
Price Elasticity of Demand:
The price elasticity of demand is the response of the quantity demanded to change in the price of a commodity. It is assumed that the consumer’s income, tastes, and prices of all other goods are steady. It is measured as a percentage change in the quantity demanded divided by the percentage change in price. Therefore, price elasticity of demand is:
Types of Price Elasticity of Demand
The extent of responsiveness of demand with change in the price is not always the same. The demand for a product can be elastic or inelastic, depending on the rate of change in the demand with respect to change in price of a product.
Elastic demand is the one when the response of demand is greater with a small proportionate change in the price. On the other hand, inelastic demand is the one when there is relatively a less change in the demand with a greater change in the price.
The various forms of price elasticity of demand are as under:
- Perfectly Elastic Demand: When a small change in price of a product causes a major change in its demand, it is said to be perfectly elastic demand. In perfectly elastic demand, a small rise in price results in fall in demand to zero, while a small fall in price causes increase in demand to infinity. In such a case, the demand is perfectly elastic.
- Perfectly Inelastic Demand : A perfectly inelastic demand is one when there is no change produced in the demand of a product with change in its price. The numerical value for perfectly inelastic demand is zero (ep=0).
- Relatively Elastic Demand : Relatively elastic demand refers to the demand when the proportionate change produced in demand is greater than the proportionate change in price of a product. The numerical value of relatively elastic demand ranges between one to infinity (ep> 1).
4 Relatively Inelastic Demand: Relatively inelastic demand is one when the percentage change produced in demand is less than the percentage change in the price of a product. For example, if the price of a product increases by 30% and the demand for the product decreases only by 10%, then the demand would be called relatively inelastic. The numerical value of relatively elastic demand ranges between zero to one (ep<1).
- Unitary Elastic Demand : When the proportionate change in demand produces the same change in the price of the product, the demand is referred as unitary elastic demand. The numerical value for unitary elastic demand is equal to one (ep=1).
A quick recap
Perfectly Elastic Demand (EP = )
Perfectly Inelastic Demand (EP = 0)
Relatively Elastic Demand (EP > 1)
Relatively Inelastic Demand (Ep< 1)
Unitary Elastic Demand ( E = 1)
Factors affecting Price Elasticity of Demand
- Price Level : The demand is generally elastic for moderately priced goods but, the demand for very costly and very cheap goods is inelastic. The rich do not bother about the prices of the goods that they buy. Very costly goods are demanded by the rich people and hence their demand is not affected much by change in prices. For example, increase in the price of Toyota car from Rs. 5,00,000 to Rs. 5,20,000 will not make any noticeable difference in its demand. Similarly, the change in the price of very cheap goods (such as salt) will not have any effect on their demand, for their consumption which is very small and fixed.
- Availability of Substitutes: If a good has close substitutes, the price elasticity of demand for a commodity will be very elastic as some other commodities can be used for it. A small rise in the price of such a commodity will induce consumers to switch their consumption to its substitutes. For example gas, kerosene oil, coal etc. will be used more as fuel if the price of wood increases. On the other hand, the demand of such commodities which have no close substitutes is inelastic, such as salt.
- Necessities : If a good is a necessity, then the demand tends to be inelastic. For example, if the price for drinking water rises, then there is unlikely to be a huge drop in the quantity demanded since drinking water is a necessity.
- Time Period : Over time, a good tends to become more elastic because consumers and businesses have more time to find alternatives or substitutes. For example, if the price of gasoline goes up, over time people will adjust for the change, i.e., they may drive less or use public transportation or form carpools.
- Habits : The demand for addictive or habitual products is usually inelastic. This is because the consumer has no choice but no pay whatever the producer is demanding. For example, if the price for a pack of cigarettes goes up, it will likely not have any effect on demand.
- Nature of the Commodities : The demand for necessities is inelastic and that for comforts and luxuries is elastic. This is so because certain goods which are essential will be demanded at any price, whereas goods meant for luxuries and comforts can be dispensed with easily if they appear to become costlier.
- Various Uses : A commodity which has several uses will have an elastic demand such as milk, wood etc. On the other hand, a commodity having only one or fewer uses will have inelastic demand. The consumer finds it easier to adjust the quantity demanded of a good when it is to be used for satisfying several wants than if it is confined to a single or few uses. For this reason, a multiple-use good tends to have more elastic demand.
- Postponing Consumption : Usually the demand for commodities, the consumption of which can be postponed, is elastic as the prices rise and are expected to fall again. For example, the demand for mp3 is elastic because its use can be postponed for some time if its price goes up, but the demand for rice and wheat is inelastic because their use cannot be postponed when their prices increase.
Income Elasticity of Demand
Income elasticity of demand is the degree of responsiveness of demand to the change in income. Prof. Watson defines it as : “Income elasticity of demand is the rate of change of quantity with respect to changes in the income, other determinants remaining constant.” The income elasticity of demand can be measured by the following formula :
Ey = Percentage change in quantity demanded/Percentage change in income
Percentage change in quantity demanded = New quantity demanded (ΔQ)/Original quantity demanded (Q)
Percentage change in income = New income (ΔY)/original income (Y)
Ey = ΔQ/Q x ΔY/Y
Income elasticity of demand, thus explains the responsiveness of demand to a change in income. Ordinarily, demand for most goods increases with increase in household’s level of income. Demand for inferior goods, however, shows a negative relation to change in income.
Types of Income Elasticity of Demand
Income elasticity of demand can be of five different types : These are tabulated with description below:
|S.No.||Numerical Measure of Income elasticity of demand||Verbal description|
|1.||Negative Demand for a commodity falls as income rises.||The trend is visible in case of inferior goods.|
|2.||Zero Demand for a commodity does not change as income changes.||This is true in the case of essential goods.|
|3.||Greater than zero but less than one.||Demand for commodity rises in proportion to a rise in income.|
|4||Unity||Demand for commodity rises in the same proportion as rise in income.|
|5.||Greater than the unity||Demand for commodity rises more than in proportion to rise in income.|
Cross Elasticity of Demand
The responsiveness of demand to changes in prices of related commodities is called cross elasticity of demand. Prof. Watson defines it as, “Cross elasticity of demand is the rate of change in quantity associated with a change in the price of related goods.” Thus cross elasticity of demand is the responsiveness of demand for commodity X to change in price of commodity Y and is represented as follows :
Cross Elasticity of Demand Ec
% increase in quantity demanded of A
% increase in price of product B
The relationship between X and Y commodities may be substitutive as in case of tea and coffee or complementary as in the case of ball pens and refills. Main measures of cross elasticity with description are as follows :
- Cross elasticity = Infinity (Commodity X is nearly a perfect substitute for commodity Y)
- Cross elasticity = Zero (Commodity X and Y are not related)
- Cross elasticity = Negative (Commodities X and Y are complementary)
Thus, if Ec approaches infinity, it means that commodity X is nearly a perfect substitute for commodity Y. On the other hand, if Ec approahes Zero it would mean that the two commodities in question are not related at all. Ec shall be negative when commodity Y is complementary to commodity X.
ELASTICITY OF SUPPLY
The elasticity of supply establishes a quantitative relationship between the supply of a commodity and it’s price. Hence, we can express the numeral change in supply with the change in the price of a commodity using the concept of elasticity. Note that elasticity can also be calculated with respect to the other determinants of supply.
However, the major factor controlling the supply of a commodity is its price. Therefore, we generally talk about the price elasticity of supply. The price elasticity of supply is the ratio of the percentage change in the price to the percentage change in quantity supplied of a commodity.
Es = [∆q/q) ×100] ÷ [(∆p/p) ×100] = (∆q/q) ÷ (∆p/p)
∆q = The change in quantity supplied
q = The quantity supplied
∆p = The change in price
p = The price
Types of Price Elasticity of Supply
- Perfectly Inelastic Supply : A service or commodity has a perfectly inelastic supply if a given quantity of it can be supplied whatever might be the price. The elasticity of supply for such a service or commodity is zero. A perfectly inelastic supply curve is a straight line parallel to the Y-axis. This is representative of the fact that the supply remains the same irrespective of the price.
The supply of exclusive items, like the painting of Mona Lisa, falls into this category. Whatever might be the price on offer, there is no way we can increase its supply.
(PES = 0), The Quantity Supplied doesn’t change as the price changes.
- Relatively Less-Elastic Supply : When the change in supply is relatively less when compared to the change in price, we say that the commodity has a relatively-less elastic supply. In such a case, the price elasticity of supply assumes a value less than 1.
(0 < PES < 1), Quantity Supplied changes by a lower percentage than a percentage change in price.
- Relatively Greater-Elastic Supply : When the change in supply is relatively more when compared to the change in price, we say that the commodity has a relatively greater-elastic supply. In such a case, the price elasticity of supply assumes a value greater than 1.
(1 < PES < 8), The Quantity Supplied changes by a larger percentage than the percentage change in price.
Source: Intelligent Economist
- Unitary Elastic Supply : For a commodity with a unit elasticity of supply, the change in quantity supplied of a commodity is exactly equal to the change in its price. In other words, the change in both price and supply of the commodity are proportionately equal to each other. To point out, the elasticity of supply in such a case is equal to one. Further, a unitary elastic supply curve passes through the origin.
(PES = 1), Quantity Supplied changes by the same percentage as the change in price.
- Perfectly Elastic supply : A commodity with a perfectly elastic supply has an infinite elasticity. In such a case the supply becomes zero with even a slight fall in the price and becomes infinite with a slight rise in price. This is indicative of the fact that the suppliers of such a commodity are willing to supply any quantity of the commodity at a higher price. A perfectly elastic supply curve is a straight line parallel to the X-axis.
(PES = ), Suppliers will be willing and able to supply any amount at a given price but none at a different price.
Factors influencing the elasticity of supply
- Price of the Good : The supply and elasticity of supply of a good depend upon the price of the good. If the price of a good increases or decreases, the quantity supplied of it will also increase or decrease, respectively. This is the law of supply. Also the coefficient of price-elasticity of supply (ES) will depend on the price of the good. ES may be greater than, less than, or equal to one, depending on the price.
- Probability that the Price would Change in Future : If the sellers think that the price of the good will increase (or decrease) in near future, then, at any particular price at present, they would want to decrease (or increase) their supply. In this case, the supply curve for the good would shift to the left (or to the right).
- Conditions regarding Cost of Production : If the cost of production of a good increases (or decreases), i.e., if its cost curve shifts upwards (or downwards), then the quantity supplied of the good would decrease (or increase) at any particular price, i.e., the supply curve would shift to the left (or to the right).
- Nature of the Good : The supply of a good depends upon the nature of the good, e.g., on the perishability and lumpiness of the good. The more the perishability or lumpiness of the good, the more would be its market localised, and, in a localised market, the supply of a good at any particular price would be relatively small.
- Length of Time : If the price of a good rises, then by how much would supply rise, or, how large will be the price-elasticity of supply, would depend on the length of time available for the necessary adjustments (e.g., in the quantities of the factor inputs used) to complete. That is why; the elasticity of supply in the long-period market would be larger than that in the short- period market.