Chapter 2B: Elasticities concept
Price elasticity of demand (PED) measures the degree of responsiveness of the quantity demanded of a good to a change in its price, ceteris parirbus
Factors affecting PED
Degree of necessity
Proportion of income spent on goods
Availability & closeness of substitutes
Time period
Applications
Producers (Non-price policies)
Government (make use of PED to consider what type of goods to tax
Marketing strategies: make demand for product less price elastic so he can increase total revenue through increase price
Timing of decisions: In short-run, prodcuers can increase price of good for price inelastic goods. In long-run, for goods which are price elastic, product innovation can be carried to make good less price elastic, then proceed to increase price of goods
Income elasticity of demand (YED) measures the degree of responsiveness of quantity demanded of every price level of a good to change in income, ceteris paribus
normal goods: YED>0 , inferior good: YED < 0
Factors affecting YED
level of income of consumers
necessity vs luxury good
Application of YED
time period
when household incomes are falling
when household incomes are rising
Cross elasticity of demand (XED) measures the degree of responsiveness of quantity demanded at every price level of one good to a change in the price of another good, ceteris paribus
Factor affectign XED: closeness of substitute or complement
Applications of XED to producers
XED>0 substitues, XED<0 complements
Pricing policy: lower price of good in response to a fall in competitor's price
Non-price policies: make good less substitutable through product differentiation, advertise to increase brand loyalty, offer two complementary goods as a package
Price elasticity of supply (PES) measures the degree of responsiveness of quantity supplied of a good to a change in its price, ceteris paribus
Factors affecting PES
length of production period
factor mobility
availability and durability of stocks
existence of spare capacity
proportion of marginal cost of production as output changes
time
Application of PES to producers
increasing spare capacity
inprove supply chain management
having buffer stock scheme
Application to government: better understand the impact of their decisions to impose a tax or price control
Limitations of elasticity concepts
assumption of ceteris paribus
reliability and accuracy of elasticity data
interaction between supply and demand