Question

Discuss the relevance of Price elasticity , Supply elasticity and Income elasticity cities, Provide one real life example for each.

Answer 1

Elasticity of Demand by Price

Price elasticity of demand is an indicator of the impact of a price change, up or down, on a product's sales.

If the price elasticity of demand is greater than 1, it is deemed elastic. That is, demand for the product is sensitive to an increase in price. A price increase for a fancy cut of steak, for example, may make many customers choose hamburger instead. A bargain price for the fancy cut will lead many customers to upgrade to the fancy cut.

Price elasticity of demand that is less than 1 is called inelastic. Demand for the product does not change significantly after a price increase. For example, a consumer either needs a can of motor oil or doesn't need it. A price change will have little or no effect on demand. But not many will stock up on motor oil if its price decreases.

Elasticity of Demand by Income

Consumers' incomes play a very important role in the demand for a good or service. When there is a change in consumers' incomes, it causes a change in the quantity demanded of a good or service if all other factors remain the same. The sensitivity of a change in the quantity demanded of a good or service relative to a change in consumers' incomes is known as income elasticity of demand. The formula used to calculate the income elasticity of demand is the percent change in the quantity demanded of a good or service divided by its percent change in consumers' incomes.

If the income elasticity of demand is greater than 1, the good or service is considered a luxury and income elastic. A good or service that has an income elasticity of demand between zero and 1 is considered a normal good and income inelastic. If a good or service has an income elasticity of demand below zero, it is considered an inferior good and has negative income elasticity.

For example, suppose a good has an income elasticity of demand of -1.5. The good is considered inferior and the quantity demanded for this good falls as consumers' incomes rise.

Supply elasticity

Overall, price elasticity measures how much the supply or demand of a product changes based on a given change in price. Elastic means the product is considered sensitive to price changes. Inelastic means the product is not sensitive to price movements.

Price elasticity of supply = % Change in Supply / % Change in Price

In a free market, producers compete with each other for profits. Since profits are never constant across time or across different goods, entrepreneurs shift resources and labor efforts towards those goods that are more profitable and away from goods that are less profitable. This causes an increase in the supply of highly valued goods and a decrease in supply for less-valued goods.

Economists refer to the tendency for price and quantity supplied to be related to the law of supply. To illustrate, suppose that consumers begin demanding more oranges and fewer apples. There are more dollars bidding for oranges and fewer for apples, which causes orange prices to rise and apple prices to drop. Producers of fruit, seeing the shift in demand, decide to grow more oranges and fewer apples because it can result in higher profits.

There are five types of price elasticity of supply, including perfectly and relatively inelastic, unit elastic, and perfectly, and relatively elastic. Here's an example of each of the five price elasticity of supply curves:

Perfect Inelastic Supply

Perfect inelastic supply is when the PES formula equals 0. That is, there is no change in quantity supplied when the price changes. Examples include products that have limited quantities, such as land or painting from deceased artists.

Relatively Inelastic Supply

The PES for relatively inelastic supply is between 0 and 1. That means the percentage change in quantity supplied changes by a lower percentage than the percentage of price change. Inelastic goods include nuclear power, which has a long lead time given the construction, technical know-how, and long ramp-up process for plants.

Unit Elastic Supply

Unit Elastic Supply has a PES of 1, where quantity supplied change by the same percentage as the price change.

Relatively Elastic Supply

A price elasticity supply greater than 1 means supply is relatively elastic, where the quantity supplied changes by a larger percentage than the price change. An example would be a product that's easy to make and distribute, such as a fidget spinner. The resources to make additional spinners are readily available and the total cost would be minimal to ramp production up or down.

Perfectly Elastic Supply

The PES for perfectly elastic supply is infinite, where the quantity supplied is unlimited at a given price, but no quantity can be supplied at any other price. There are virtually no real-life examples of this, where even a small change in price would dissuade, or disallow, product makers from supplying even a single product.