The Concept of Elasticity - Report Example

Elasti Table of Contents Introduction 3 Concepts of Elasti 3 Importance of Income Elasti and Cross Price Elasti of Demand 4 Effect of a change in Price Elasticity of Demand 5 Conclusion 7 References 7 Besanko, D. & Braeutigam, R. (2010). Microeconomics (4th Edition). London: Wiley. 7 Boyes, W. & Melvin, M. (2007) Microeconomics (7th Edition). Cengage Learning. 7 Frank, R. H. & Bernanke, B. S. (2006). Principles of Economics (3rd Edition). New York: McGraw-Hill. 7 Gillespie, A. (2007). Foundations of Economics. Oxford: OUP. 7 Lindeman, J. B. (2002) Microeconomics (2nd Edition). New York : Barron’s. 7 Webster, T. J. (2003). Managerial economics: theory and practice. London: Elsevier. 7 Bibliography 7 Mankiw, N. G. (2008). Essentials of Economics. New York: Cengage Learning. 7 Introduction The concept of elasticity is one of the oldest and most useful of all in the world of economics. Elasticity quantifies the effect of a price change of a particular commodity, on various other aspects dependent on it. Though such a definition might instigate the reader to try to conceive as many such elements as possible, there are merely four of them that businessmen find useful, namely, price elasticity of demand (PEd), price elasticity of supply (SEd), cross-price elasticity of demand (XEd) and income elasticity of demand (YEd). Unless these concepts are well known, the businessmen cannot predict their buyer’s traits and hence, trends of the market system. The present paper shows how an innate knowledge of every one of the aforementioned variants of elasticity is important for a producer to frame her strategies efficiently. Concepts of Elasticity As mentioned before, the paper deals with four variants of elasticity each of which have been defined underneath. Price elasticity of demand (PEd) – It is the percentage change in the quantity demanded of a particular commodity owing to a percentage change in the price of the same (Frank & Bernanke, 2006, p. 99). Let X is a commodity, with (P0, Q0) and (P1, Q1) be the representatives of initial and latest sets of price and quantity. Suppose, for X, P0X = 5, Q0X = 10 and P1X = 10, Q1X = 7. Then, PEdX = [(7 – 10)/ 10]/ [(10 – 5)/ 5] = -0.3 Price elasticity of supply (SEd) – It is the percentage change in the quantity being supplied of a particular commodity due to a percentage change in the price of the same (Boyes & Melvin, 2007, p. 130). Hence if, in the above example, P0S = 5 and P1S = 4, then, SEd = [(7 – 10)/ 10]/ [(4 – 5)/ 5] = 1.5 Income elasticity of demand (YEd) – This is the percentage change in demand of a commodity due to a percentage change in the income of the demander (Gillespie, 2007, p. 53). Hence, if, M0 = 150 and M1 = 100, then for X, YEd = [(7 – 10)/ 10]/ [(100-150)/ 150] = 0.9. Cross-price elasticity of demand (XEd) – It is the percentage change in the quantity demanded of one commodity due to a percentage change in the price of another (Besanko & Braeutigam, 2010, p. 52). Let Y be another commodity where P0Y = 9 nd P1Y = 12, then, XEd = [(7 - 10)/ 10]/ [(12 - 9)/ 9] = -0.9. Importance of Income Elasticity and Cross Price Elasticity of Demand Businessmen need to keep a track of the values of income elasticity of demand since a change in income might mean a shift in the tastes and preferences of the consumers, which might or might not be optimistic news for the producers. In case that a good has a high YEd, it is likely to be adversely affected due to a fall in income. Hence, a businessman must be aware of the anticipated changes in income so as to deduce the traits of demand and hence frame his policies accordingly. On the other hand, awareness about the cross price elasticity of demand is necessary to stay updated about the behavioural pattern of consumer tastes when exposed to a wide range of commodities. In case there are many substitutes, the producer has reason to worry; but the presence of many complements can ensure a stable demand. Effect of a change in Price Elasticity of Demand Demand is said to be inelastic when a certain change in price is likely to produce a less than proportionate change in demand for a commodity. On the other hand, if a slight change in price produces huge change in quantity demanded, the demand is said to be elastic in nature. In case the commodity involved is featured by an inelastic demand, it is likely to produce little impact upon the total revenue, while total revenue will be hugely affected in case a commodity is characterised by elastic demand (Webster, 2003, p. 174). When the commodity is featured by an elastic demand In this case the demand curve is has a flat slope so as to indicate that a change in price leads to a higher than proportionate increase in the quantity demanded. On the other hand, if the demand is elastic in nature then the impact of a change in the level of price is bound to be quite high upon the total revenue being earned by the producer. This is obvious from the diagram alongside that shows that at point A of the demand schedule, the total revenue being earned is equal to TR0. However, a fall in the level of price leads to a more than proportionate increase in the quantity demanded, so that ultimately it is reflected through higher total revenue being earned. In the present case, TR1 is greater than TR0, indicating that elastic demand might lead to a rise in total revenue being earned out of a negative price change. When the commodity is featured by an inelastic demand There is not much difference in analysis in this case. The only point to be noted is that even though a falling price has a positive impact on the quantity being demanded, the change in total revenue is positive only marginally. The change in total revenue is might even had been a negative one had the demand been more inelastic (Lindeman, 2002, p. 49). Thus, elastic demand is bound to be reflected through a significant rise in total revenue, which might not be so if the demand is inelastic. An example of a commodity with elastic demand is that of air-conditioners. In case its price rises too high, aggregate demand for the product falls remarkably. On the other hand, example of a good with an inelastic demand is that of medicines, which are necessary for a healthy life. No matter how much the price rises or falls, demand for the same remains almost unchanged. Neither do people consume more and more medicines in case of a price reduction and nor can they leave it in cases of a rise in price. Conclusion The impact of a rise in price hence, has a significant impact upon the total revenue earned by a producer. While commodities with a high elasticity are bound to be associated with a sharp rise in total revenue in case of a fall in price, that for inelastic goods might not be guaranteed. Hence, an innate knowledge of elasticity principles is important for producers before they frame policies for their organisation. References Besanko, D. & Braeutigam, R. (2010). Microeconomics (4th Edition). London: Wiley. Boyes, W. & Melvin, M. (2007) Microeconomics (7th Edition). Cengage Learning. Frank, R. H. & Bernanke, B. S. (2006). Principles of Economics (3rd Edition). New York: McGraw-Hill. Gillespie, A. (2007). Foundations of Economics. Oxford: OUP. Lindeman, J. B. (2002) Microeconomics (2nd Edition). New York : Barron’s. Webster, T. J. (2003). Managerial economics: theory and practice. London: Elsevier. Bibliography Mankiw, N. G. (2008). Essentials of Economics. 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