Supply and Demand and Price Elasticity

Only available on StudyMode
  • Download(s) : 122
  • Published : April 9, 2009
Open Document
Text Preview
ELASTICITY
Introduction & Definition:
Elasticity is defined as a general concept used to quantify the response in one variable when another variable changes. Economist usually measure responsiveness using the concept of elasticity. Elasticity is a general concept that can be used to quantify the response in one variable when another variable changes. So, we can say that if some variable X changes in response to changes in another variable Y, the elasticity of X with respect to Y is equal to the percentage change in X divided by the percentage change in Y. The formula is stated as below: Elasticity of X with respect to Y = %∆X

%∆Y

PRICE ELASTICITY of DEMAND
Definition:
Price elasticity of demand is defined as the degree of responsiveness of the quantity demanded of a good to a change in its price, ceteris paribus, when all other factors on buyers’ plans are being unchanged. Formula: Calculating Price Elasticity of Demand

Price elasticity of demand = Percentage change in quantity demanded Percentage change in price

= %∆ Q %∆P

Types of Price Elasticity of Demand (Inelastic and Elastic Demand): 1) Fairly elastic demand
Fairly elastic demand is the percentage change in the quantity demanded exceeds the percentage change in price. The price elasticity of demand, n is greater than 1 and the good is said to have a fairly elastic demand. The examples of goods or services that have fairly elastic demand are automobiles, international travels, transportation services and others. These goods or services are easy to avoid and they have many substitutes. The quantity demanded of goods or services are responsive or sensitive to changes in price. The given graph illustrates the demand for a good with a fairly elastic of demand: Price

(Flat curve)
5% P0
P1
DD

Quantity 0 Q0 Q1 15%

For example, the price of the good falls by 5% and the quantity demanded for it rises 15%. Calculate the price elasticity of demand.
Price elasticity of demand, n = %∆Q
%∆P

= 15
5

= 3
n > 1, therefore the good is said to have a fairly elastic demand. 2) Fairly inelastic demand
Fairly inelastic demand is the percentage change in the quantity demanded is less than the percentage change in price. In this case, the price elasticity of demand, n is between 0 and 1. The examples of goods or services that have inelastic demand are food, tobacco, housing services, banking services and many others. These goods and services are difficult to avoid and they only have a few substitutes. The quantity demanded of goods and services are unresponsive or not sensitive to changes in price. The given graph illustrates the demand for a good with fairly inelastic demand.

Price
(Steep curve)
P0
5%
P1

DD
Quantity 0 Q0 Q1
3%
For example, the price of the good falls by 5% and the quantity demanded for it rises 3%. Calculate the price elasticity of demand.
Price elasticity of demand, n = %∆Q...
tracking img