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Chapter 2B: Resource Allocation: Elasticities of Demand and Supply -…
Chapter 2B: Resource Allocation: Elasticities of Demand and Supply
Price Elasticity of Demand (PED): measures the degree of responsiveness of the quantity demanded of a good to a change in its price, ceteris paribus. {percentage change in quantity demanded divided by percentage change in price of good}
0<|PED|<1 ~ relative price inelastic, demand for a good is price inelastic when a change in price results in a less than proportionate change in quantity demanded, ceteris paribus. This is illustrated by a steep demand curve.
|PED|=1 ~ unitary price elastic, demand for a good is unitary price elastic when the change in price of a good leads to a proportionately equal change in qty demanded, ceteris paribus. This is illustrated by a curve displayed as a straight line at 45 degrees or a curve concave from the origin.
1<|PED|<infinite ~ relative price elastic, demand for a good is price elastic when a change in the price of the good leads to a more than proportionate change in quantity demanded. ceteris paribus. This is illustrated by a gentle demand curve.
|PED|= Infinite ~ perfectly price elastic, demand for a good is perfectly price elastic when a change in price demanded leads to an infinitely large effect on quantity demanded, ceteris paribus. This is illustrated by a vertical line.
|PED|=0 ~ perfectly price inelastic, demand for a good is perfectly price inelastic when a change in price leads to no change in quantity demanded, ceteris paribus. This is illustrated by a horizontal line.
Pricing strategies rely greatly on the price elasticity of demand of a good. If the demand of a good is relatively price elastic, the producer will have to consider that a change in price of good/service will result in a more than proportionate change in quantity demanded and therefore a decrease in total revenue. Information a producer would need to know before making such an adjustment would be : Availability and closeness of substitutes, Degree of necessity, proportion of income spent on this good, Time period. NOn- price policies or output strategies inc. marketing strategies and timin of decisions on pricing and marketing.
Price Elasticity of Supply (PES) : measures the degree of responsiveness of quantity supplied of a good to changes in its price, ceteris paribus, calculated by percentage change in quantity supplied divided by percentage change in the price of good.
Pes=1 When a change in price leads to an equal proportionate change in quantity supplied, unitary price elastic.
pes=infinity, perfectly price elastic
Pes< 1proportionately smaller change in quantity supplied, price inelastic
pes=0 perfectly price inelastic
Pes>1 proportionately larger change in quantity supplied, price elastic
Income Elasticity of Demand (YED):measures the degree of responsiveness of demand of a good to a change in income, ceteris paribus. {percentage change in quantity demanded at each price divided by the percentage change in income}
Inferior goods-YED<0, an increase in income leads to a decrease in demand, vice versa, ceteris paribus.
Normal goods-YED>0, an increase in income will lead to an increase in demand, vice versa, ceteris paribus.
Luxury goods 1<YED< infinity ~income elastic
Necessity 0<YED<1 ~income inelastic
Cross Elasticity of Demand (XED) : measures the degree of responsiveness of the demand of one good to a change in the price of another and can be calculated by percentage change of quantity change of good X divided by the percentage change in price of good Y
COMPLEMENTS XED<0
UNRELATED PRODUCTS XED=0
SUBSTITUTES XED>0
THE MAGNITUDE OF COEFFICIENT, the larger the numerical value of the coefficient, the closer the relationship between the two goods are... If the magnitude of the XED value is large, the change in price of complement/substitute good will result in a significant change in demand for the substitute good.
APPLICATIONS TO PRODUCERS; A producer may have a product which has high magnitude of XED>1 with a close competitor. pricing policies where predatory pricing is used to drive out comp. in order to obtain mkt share dominance. Non pricing policies such as marketing strategies like product differentiation and strong ad campaigns in order to increase brand loyalty and fame, increasing its own PED and making its product price inelastic - 0<|PED|<1
CONCLUSION STUFF, LIMITATIONS OF ELASTICITY CONCEPTS.....
HOWEVER,
1) The assumption of ceteris paribus the all other factors hold unchanged,
2) Reliability and Accuracy of elasticity data may affect the accuracy and as such, the efficacy of such elasticity concepts.