Economics Notes. Elasticity of Demand and Supply.

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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 ↓ & Price ↓ => demand ↑.

  • If a firm has inelastic demand for its product and wishes to increase total revenue, it should raise the price of its product.
  • If a firm has elastic demand for its product and wishes to increase total revenue, it should not raise the price of its product.
  • In unitary elastic demand: the revenue does not change since there is proportional increase and decrease.
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  • Determinants of PED:
  •  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:

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