Price Elasticity of Demand and Supply - Essay Example

Introduction In economics, elasti signifies the measurement of change that is introduced in one variable when one or more of the other variables are changed. For instance, the questions as to how much would I sell more if the price of my product is lowered, how much less would I sell if the price of my product is increased as well as if a particular resource is scarce, will that provoke a scramble for that resource are answered by making use of the concept of elasticity. If we use more technical jargon to define elasticity, it would be that it measures the percentage change in one variable to the percentage change in another variable. The function of responsiveness of a particular variable to the change in parameters of the other variables is what elasticity is all about. The frequently used dimensions of elasticity include price elasticity of demand, price elasticity of supply, income elasticity of demand and elasticity of substitution between factors of production. Because of the immense contribution that the concept of elasticity has made to the study of responsiveness of price and other factors to changes in demand and supply, it has indeed made a significant contribution to the understanding of the market and agents in its. This is the topic for this paper and the subsequent paragraphs discuss the concept in detail along with the example of a supermarket to elucidate the concept. Price Elasticity of Demand If we take the first dimension or the PED (Price Elasticity of Demand), this is the percentage change in the quantity demanded for a drop or rise in price and hence measures how “elastic” the demand is to a change in the price of the good. The measurement of PED is by dividing the percentage change in the quantity demanded by the percentage change in the price and since either the percentage change in demand or the percentage change in price is negative, the PED is always negative. Hence, the PED is usually expressed in terms of absolute values. Goods that have a PED of more than 1 are supposed to be highly elastic meaning that changes in price have a large effect on the change in demand. On the other hand, goods that have a PED less than 1 or between 0 and 1 are supposed to be inelastic or relatively inelastic. This is because the change in demand is not that much greater for a change in price (Ayers & Collins, 2003). If we apply this dimension to the case of the supermarket, we find that goods like alcoholic beverages and luxury products like perfumes and cosmetics are highly elastic since a drop in the price invariably leads to greater demand from the consumers. This is the reason why supermarkets tend to lower the prices of these products during Christmas because of the fact that people tend to buy more of these products during that time and hence lowering their price leads to greater than the normal quantity being bought leading to a double whammy effect. Similar is the case with soft drinks and other fast moving consumer items. However, the elasticity of eggs is found to be relatively low or they are inelastic and hence supermarkets do not stand to gain by lowering the prices of eggs. Hence, the PED can be explained in this way for supermarkets. Price Elasticity of Supply The next dimension that is being discussed is the PES (Price Elasticity of Supply) that measures the change in the supply of goods for a change in the price. Similar to the case of the PED, PES measures the percentage change in the quantity of goods supplied to a percentage change in the price and the absolute value of PES is taken to denote the elasticity or inelasticity of the specific good. For instance, if the PES is less than 1 then the good is considered inelastic wherein changes in price do not affect the supply of the good to the extent that happens when the changes in price affect supply to a greater extent as is the case with those goods for whom the PES is more than 1 (Perloff, 2008). Goods like Tobacco are highly elastic to changes in price and hence the supermarkets would have to stock up more in case the price is falling since supply would be greatly diminished. Though by no stretch of imagination can one expect the price of tobacco to fall drastically, nonetheless it is illustrative of the fact that supermarkets need to stock up on items that are highly supply elastic as changes in price may reflect the diminishing supply of these goods. This is the case when taxes on some of the elastic goods are lowered to commemorate special occasions and this is when the supply becomes less leading to the supermarkets having to keep the stock of such goods available. Income Elasticity of Demand The third dimension that we are discussing is the income elasticity of income that measures the responsiveness of the demand for a good to a change in the income of the people demanding the good. The calculation of this is the measurement of the percentage change in demand to the percentage change in income. By this reckoning, a negative elasticity of demand (income) is associated with inferior goods that are consumed less when income increases. The supermarket example would be the consumption of substitutes of expensive luxury goods that might go down with the rising income levels of the neighbourhood in which the supermarket is located. On the other hand, a positive elasticity of income is associated with normal goods or goods whose demand increases with increases in income. And if the income elasticity of demand is less than 1, then it is a necessary good whereas if the income elasticity of demand is greater than 1, then it is a luxury good or a superior good (Wride & Sloman, 2010). The case of the supermarket is that during month ends and festival season, when greater income is the case, the supermarket can well stock up on those goods that have greater income elasticity of demand since the demand for such goods would increase. The supermarkets would anyway stock up more on all goods during these times but it would be extra profitable to stock more of those goods like Alcohol, Cosmetics and other luxury items whose income elasticity of demand is more. Cross Elasticity of Demand There is also the elasticity associated with the cross elasticity wherein the change in price of one product affects the change in demand of another. For a supermarket, the example would be the cross elasticity of demand between butter and margarine and hence the supermarket would be well advised to stock up more of one if the price of the other goes up. Similar is the case with beef and pork and this is a clear example of how the supermarket can manage the demand of these products according to the changes in price of either (O’Sullivan & Sheffrin, 2005). Conclusion This paper has discussed the different dimensions of the concept of elasticity and has provided in-depth detail about how they relate to the example of a supermarket. The way in which supermarkets anticipate demand and regulate supply is a clear indication of the principle of elasticity at work. In conclusion, the concept of elasticity has indeed made a significant contribution to our understanding of the market and the agents in it. Hence, the concept of elasticity is useful and indeed used widely in the realm of market economics. References Ayers, T., & Collins, M. (2003). Microeconomics. London: Pearson. OSullivan, A., & Sheffrin, S. (2005). Microeconomics (4th Ed.) London: Pearson. Perloff, J. (2008). Microeconomics Theory & Applications with Calculus. London: Pearson Wride, A., & Sloman, J., (2010) Economics (7th Ed.) London: John Wiley & Sons. Read More