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Economics Notes. Elasticity of Demand and Supply.

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Introduction

CHAPTER 5: ELASTICITY * Elasticity: Measure of responsiveness. * Elasticity of demand: Measure of how much demand for a product changes when there is change in any one of the determinants. Three elasticities of demand: - Price elasticity of demand. - Cross elasticity of demand. - Income elasticity of demand. * PRICE ELASTICITY OF DEMAND: Measure of how much demand for a product changes with a change in price. PED = % change in quantity demanded i.e. %?QD % change in price of product. %?P The value for PED is negative since there is an inverse relationship between price and demand but the negative sign is ignored generally. Price � => demand v & Price v => demand �. Perfectly Inelastic Demand. Perfectly Elastic Demand. Unitary Elastic Demand. Inelastic Demand. Elastic Demand. PED = 0 PED = ? PED = 1 0 < PED < 1 1 < PED < ? Change in price of the product has no effect on the quantity demanded. Even if there is a small increase in price, demand falls to 0. Change in price leads to equal and opposite change in demand. ...read more.

Middle

Since the government does not want to increase unemployment, taxes are imposed on products which have relatively inelastic demand so that demand doesn't fall by a greater amount. * Cross Elasticity of Demand: Measure of how much the demand of a product changes with change in price of another product. Explains the relationship between products. XED = % ? QD of product 'X' %? in price of product 'Y' Range of values for XED: If XED is +ve i.e. XED>0. The two goods are substitutes of each other. Closer substitutes have higher +ve value. Example: Two types of sugar can be close substitutes. The increase in price of one will lead to a fall for demand of it, and hence an increase in demand for the competitor's sugar. If XED is -ve i.e. XED<0. The two goods are complement to each other. Closer complements will have lower -ve value. Example: Car and petrol. Cars require petrol to run on and petrol is required to be put into cars. If XED = 0. The two goods are unrelated i.e. the change in price of one has no effect in the demand of the other good. ...read more.

Conclusion

Unitary Elastic Supply. Inelastic Supply. Elastic Supply. PES = 0 PES = ? PES = 1 0 < PES < 1 1 < PES < ? Change in price of the product has no effect on the quantity supplied. Even if there is a small decrease in price, demand falls to 0. Change in price leads to proportionate change in QS. Change in price of product leads to proportionally smaller change in quantity supplied. Change in price of product leads to proportionally greater change in quantity supplied. Supply Curves Rules: - Any straight line supply curve passing through the origin has elasticity of 1. - Any straight line supply curve starting from the x-axis has PES value < 1. - Any straight line supply curve starting from the y-axis has PES value > 1 * Determinants of PES. - How much costs rise as output increased: If total costs of supplying rises, more likely that the producer will not raise supply so PES will be relatively inelastic. If total costs do not rise quickly, producer will raise supply and benefit from higher prices thus making profits. - Time period: Longer the time period considered more elastic will be supply. ...read more.

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