- Number and closeness of substitutes:
- More number of substitutes => Demand is more elastic i.e. if there is an increase in price, there will be a proportionally greater fall in demand and consumers will switch to substitute products.
- The more closer the substitutes => Demand is more elastic.
Example: different brands of chips etc.
- Necessity of product and its definition:
- More the necessity for demand => Demand is inelastic.
- The more narrower the product is defined, demand will be elastic.
- Necessity & tates vary from consumer to consumer.
Example:
- In the short term, demand is more inelastic since it is hard for consumers to change their buying habits in a short time.
- In the long term therefore, demand becomes elastic.
If the government imposes indirect taxes on the goods, the price will most likely rise. And, if demand is very elastic then a small increase in the price will lead to a proportionally greater fall in demand as a result of the imposition of tax on the product. Fall in demand means demand for production workers will decrease thus increasing employment in the economy.
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.
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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:
- It is important for all firms to know the XED values of their products since they should be aware of the consequences of demand for their product if there is a change in price of a close rival’s product. They should also be aware of the price changes they make which will affect the demand of the rival’s products.
- Firms that produce complementary goods should be aware the change in demand for the complement product if they make a price change in their product.
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Income Elasticity of Demand (YED): Measure of how much the demand of product changes with a change in consumer’s income.
YED = %∆ QD of the product
%∆ in income of consumer.
Range of values for YED:
- Necessity goods have low income-elasticity since demand will not change much even if income rises.
- Superior goods have high income-elasticity i.e. demand for them changes significantly if income rises. Example: demand for holidays in foreign countries.
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ENGEL CURVE: This shows the relationship between QD and income. As income increases, QD of the product may increase, then become constant and finally decrease as people buy superior goods.
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Price Elasticity of Supply: Measure of how much supply of a product changes when there is change in the price of the product.
PES = %∆ QS of the product
%∆ in price of the product.
Range of values of PES.
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
- 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.
Longer the time period considered more elastic will be supply.