Elasticities

Elasticities

The responsiveness of an economic variable (such as the quantity demanded or supplied of a product) to a change in another economic variable (such as its price or income).

Calculation of Elasticity

• PED = % change of quantity demanded / % change of price
• PES = % change of quantity supplied / % change of price
• YED = % change of quantity demanded / % change of income {.grid-list}

Price elasticity of demand (PED)

A measure of the responsiveness of the quantity demanded of a good or service to a change in its price.

Range of PED values

• Perfect inelastic: PED = 0 (D is a vertical line)
• Inelastic: 0<PED<1
• Unit: PED = 1
• Elastic: 1<PED<∞
• Perfect elastic: PED = ∞ (D is a horizontal line) {.grid-list}

The value of PED is determined by the slope and the portion of the demand curve.

Determinants of PED

• The number and closeness of substitutes
• The degree of necessity: necessities & luxuries
• Length of time
• The proportion of income spent on the good

Applications of PED

• PED and total revenue: how firms make decision
• PED and indirect taxes: how government make decision
• PED and Primary commodities and manufactured products

Income elasticity of demand (YED)

The measure of the responsiveness of demand (and hence a shifting demand curve) for a good to a change in consumers’ income.

Types of goods and their YED

Normal goods have a positive YED value. YED > 0 Inferior goods have a negative YED value. YED < 0

Necessity goods: income inelastic (0<YED<1) Luxury goods: income elastic (YED > 1)

An Engel curve

A graph that show how quantity demanded varies with the level of consumer income. It shows the relationship between income and the Demand for a product over time.

Price elasticity of supply (PES)

The measure of the responsiveness of quantity supplied of a good to a change in the price, along a given supply curve.

Range of PES

• Perfect inelastic: PES = 0 (S is a vertical line)
• Inelastic: 0<PES<1
• Unit: PES = 1
• Elastic: 1<PES<∞
• Perfect elastic: PES = ∞ (S is a horizontal line) {.grid-list}

Determinants of PES

• Length of time
• Mobility of factors of production
• Spare (unused) capacity
• Ability to store stocks
• Rate at which costs increase