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Elasticity of Supply
Micro Economics
Elasticity of SupplyA measure of the responsiveness of the quantity supplied to a price change.
The elasticity of supply measures the responsiveness of the quantity supplied to a change in the price of a good when all other influences on selling plans remain the same.
Elasticity of SupplyCalculating the Elasticity of Supply
formula: Percentage change in quantity
supplied Percentage change in price
Price Elasticity of Demand Total Revenue and Elasticity
The total revenue from the sale of good or service equals the price of the good multiplied by the quantity sold. (P x Q)
When the price changes, total revenue also changes.
But a rise in price doesn’t always increase total revenue.
Price Elasticity of DemandThe change in total revenue due to a change in price depends on the elasticity of demand: If demand is elastic, a 1 percent price cut increases the quantity sold by more than 1 percent, and total revenue increases. If demand is inelastic, a 1 percent price cut decreases the quantity sold by more than 1 percent, and total revenues decreases. If demand is unit elastic, a 1 percent price cut increases the quantity sold by 1 percent, and total revenue remains unchanged.
Price Elasticity of Demand
The total revenue test is a method of estimating the price elasticity of demand by observing the change in total revenue that results from a price change (when all other influences on the quantity sold remain the same). If a price cut increases total revenue, demand is
elastic. If a price cut decreases total revenue, demand is
inelastic. If a price cut leaves total revenue unchanged, demand is unit elastic.
Price Elasticity of Demand
Your Expenditure and Your Elasticity If your demand is elastic, a 1 percent price cut
increases the quantity you buy by more than 1 percent and your expenditure on the item increases.
If your demand is inelastic, a 1 percent price cut increases the quantity you buy by less than 1 percent and your expenditure on the item decreases.
If your demand is unit elastic, a 1 percent price cut increases the quantity you buy by 1 percent and your expenditure on the item does not change.
Price Elasticity of DemandThe Factors That Influence the Elasticity of Demand The elasticity of demand for a good
depends on:The closeness of substitutesThe proportion of income spent on the
goodThe time elapsed since a price change
Price Elasticity of Demand Closeness of Substitutes The closer the substitutes for a good or
service, the more elastic are the demand for it. Necessities, such as food or housing, generally have inelastic demand. Luxuries, such as exotic vacations,
generally have elastic demand.
Price Elasticity of Demand
Proportion of Income Spent on the Good
The greater the proportion of income consumers spent on a good, the larger is its elasticity of demand.
Time Elapsed Since Price Change The more time consumers have to adjust to
a price change, or the longer that a good can be stored without losing its value, the more elastic is the demand for that good.
More Elasticities of Demand Cross Elasticity of Demand
The cross elasticity of demand is a measure of the responsiveness of demand for a good to a change in the price of a substitute or a complement, other things remaining the same.
The formula for calculating the cross elasticity is:
Percentage change in quantity demandedPercentage change in price of substitute or
complement
Independent Goods A Zero or near Zero cross elasticity
suggests that the two products are unrelated or independent goods.
Example: We would not expect a change in the price of butter to have any impact on the purchases of film.
Elasticity of Supply Calculating the Elasticity of Supply
The elasticity of supply is calculated by using the formula:
Percentage change in quantity supplied Percentage change in price
Calculate elasticity of Supply
Price per bunch of five daffodils
Qs supplied per month
$1 10000
$2 12000
answer Es= 0.2
Do the calculation Here is supply
schedules for natural rubber and man made rubber
Calculate price elasticity of supply for natural rubber and man made rubber
Price per lb Qs of natural rubber per month
$0.80p 1000$1.00 1100Price per lb Qs of man
made rubber per month
$0.80p 2000$1.00 2800
Elasticity of Supply
Elasticity and Total Revenue
When demand is inelastic, price and total revenues are directly related. Price increases generate higher revenues.
When demand is elastic, price and total revenues are indirectly related. Price increases generate lower revenues.
Type of demand Value of Ed
Change in quantity versus change in price
Effect of an increase in price on total revenue
Effect of a decrease in price on total revenue
Elastic Greater than 1.0
Larger percentage change in quantity
Total revenue decreases
Total revenue increases
Inelastic Less than 1.0 Smaller percentage change in quantity
Total revenue increases
Total revenue decreases
Unitary elastic
Equal to 1.0 Same percentage change in quantity and price
Total revenue does not change
Total revenue does not change
TR P Q
ElasticityPrice
Quantity Demanded (000s)
D
The importance of elasticity is the information it provides on the effect on total revenue of changes in price.
£5
100
Total revenue is price x quantity sold. In this example, TR = £5 x 100,000 = £500,000.This value is represented by the grey shaded rectangle.
Total Revenue
ElasticityPrice
Quantity Demanded (000s)
D
If the firm decides to decrease price to (say) £3, the degree of price elasticity of the demand curve would determine the extent of the increase in demand and the change therefore in total revenue.
£5
100
£3
140
Total Revenue
ElasticityPrice (£)
Quantity Demanded
10
D
5
5
6
% Δ Price = -50%% Δ Quantity Demanded = +20%Ped = -0.4 (Inelastic)Total Revenue would fall
Producer decides to lower price to attract sales
Not a good move!
ElasticityPrice (£)
Quantity Demanded
D
10
5 20
Producer decides to reduce price to increase sales
7
% Δ in Price = - 30%% Δ in Demand = + 300%
Ped = - 10 (Elastic)Total Revenue rises
Good Move!
Elasticity If demand is price
elastic: Increasing price
would reduce TR (%Δ Qd > % Δ P)
Reducing price would increase TR (%Δ Qd > % Δ P)
If demand is price inelastic:
Increasing price would increase TR (%Δ Qd < % Δ P)
Reducing price would reduce TR (%Δ Qd < % Δ P)
Elasticity
Income Elasticity of Demand:
A positive sign denotes a normal good A negative sign denotes an inferior good
Elasticity For example: Yed = - 0.6: Good is an inferior good but inelastic – a rise in
income of 3% would lead to demand falling by 1.8%
Yed = + 0.4: Good is a normal good but inelastic – a rise in incomes of 3% would lead to demand rising by 1.2%
Yed = + 1.6: Good is a normal good and elastic – a rise in incomes of 3% would lead to demand rising by 4.8%
Yed = - 2.1: Good is an inferior good and elastic – a rise in incomes of 3% would lead to a fall in demand of 6.3%
How will the following changes in price affect total revenue _TR increases, decreases or remains unchanged.
a. Price falls and demand is inelasticb. Price rises and demand is elasticc. Price rises and supply is elasticd. Price rises and supply is inelastice. Price rises and demand is inelasticf. Price falls and demand is elasticg. Price falls and demand is of unit
elasticity
Answers; TR will
a. decreasesb. decreasesc. Increasesd. Increasese. Increasesf. Increasesg. remains same
What are the major determinants of price elasticity of demand?Use these determinants in judging whether
demand for each of the following products is elastics or inelastic:
a) Orangesb) Cigarettesc) Winston cigarettesd) Gasolinee) Butterf) Salt
g. Automobilesh. Football gamesi. Diamond braceletj. This text book
Answers!a. elasticb. inelasticc. elasticd. inelastice. elasticf. inelasticg. elastich. elastici. elasticj. inelastic