Zamboanga City State Polytechnic College

R.T Lim Blvd Baliwasan, Zamboanga City

COLLEGE OF TEACHER EDUCATION

Discussants: Indab, Rowena

Orañola, Dean Andree
Cornelio, Cherry Mae B.
Balan, Alondra Jane M.
Casusie, Salymer S.
Luna, Shiela T.

Subject: SOC. SCI. 111 - ECONOMICS WITH PRINCIPLES OF

TAXATION AND AGRAGRIAN REFORM

Date: November 03, 2020

Teacher: Ms. Regine D. Econg

Topic: ELASTICITY AND ITS APPLICATION

OUTLINE OF THE TOPIC

I. ELASTICITY AND ITS APPLICATION

A. PRICE EALSTICITY OF DEMAND AND PRICING DECISIO N

What is Elasticity?

Is a measure of how much buyers and sellers respond to the changes in market
conditions.

Alfred Marshall introduced the concept of elasticity in economics.

What is price elasticity?

It measure the responsiveness of the quantity demanded to the change in price. -

According to Boulding.

Quantity demanded respond strongly to the price changes.

Quantity demanded does not response strongly to changes in price.

Quantity demanded changes infinitely with any change in price.

Quantity demanded does not respond to price changes.

Quantity demanded changes by the same percentage as price.

Role of Price Elasticity of Demand in Decision-Making

The concept of elasticity of demand plays a crucial role in the pricing decisions of
the business firms and the Government when it regulates prices. The concept of
price elasticity is also important in judging the effect of devaluation or depreciation
of a currency on its export earnings.

It has also a great use in fiscal policy because the Finance Minister has to keep in
view the price elasticity of demand when it considers to impose taxes on various
commodities. We shall explain below the various uses, applications and
importance of the elasticity of demand.
The business firms take into account the price elasticity of demand when they take
decisions regarding pricing of the goods. This is because change in the price of a
product will bring about a change in the quantity demanded depending upon the
coefficient of price elasticity.

This change in quantity demanded as a result of, say a rise in price by a firm, will
affect the total consumer’s expenditure and will therefore, affect the revenue of the
firm. If the demand for a product of the firm happens to be elastic, then any
attempt on the part of the firm to raise the price of its product will bring about a
fall in its total revenue.

Thus, instead of gaining from the increase in price, it will lose if the demand for its
product happens to be elastic. On the other hand, if the demand for the product of a
firm happens to be inelastic, then the increase in price by it will raise its total
revenue. Therefore, for fixing a profit-maximizing price, the firm cannot ignore the
price elasticity of demand for its product.

Price elasticity of demand can be used to answer the following types of

questions:

1. What will be the effect on sales if a firm decides to raise the price of its product,
say by 5 percent.

2. How large a reduction in price of a product is required to increase sales, say by

25 percent.

It has been found by some empirical studies that business firms often fail to take
elasticity into account while taking decisions regarding prices, or they give
insufficient attention to the coefficient of price elasticity. No doubt, the main
reason for this is that they don’t have the means to calculate price elasticity for
their product, since sufficient data regarding past prices and quantity demanded at
those prices are not available.

Even if such data are available, there are difficulties of interpretation of it because
it is not clear whether the changes in quantity demanded were the result of changes
in price alone or changes in some other factors determining the demand.

B. INCOME ELASTICITY OF DEMAND

What Is the Income Elasticity of Demand?

Income elasticity of demand refers to the sensitivity of the quantity demanded for a
certain good to a change in real income of consumers who buy this good, keeping
all other things constant.
The formula for calculating income elasticity of demand is the percent change in
quantity demanded divided by the percent change in income. With income
elasticity of demand, you can tell if a particular good represents a necessity or a
luxury.

Income elasticity of demand measures the responsiveness of demand for a

particular good to changes in consumer income. The higher the income elasticity of
demand in absolute terms for a particular good, the bigger consumers' response in
their purchasing habits—if their real income changes. Businesses typically
evaluate income elasticity of demand for their products to help predict the impact
of a business cycle on product sales

Calculation of Income Elasticity of Demand

Suppose that initial income of a person is 2000 pesos and quantity demanded for
the commodity by him is 20 units
When his income increases to 3000 pesos quantity demanded by him also increases
to 40 units.
Find out the income elasticity of demand

Solution

Types of Income Elasticity of Demand

There are five types of income elasticity of demand:

High: A rise in income comes with bigger increases in the quantity demanded.

Unitary: The rise in income is proportionate to the increase in the quantity

demanded.
Low: A jump in income is less than proportionate than the increase in the quantity
demanded.

Zero: The quantity bought/demanded is the same even if income changes

Negative: An increase in income comes with a decrease in the quantity demanded.

Interpretation of Income Elasticity of Demand

Depending on the values of the income elasticity of demand, goods can be broadly
categorized as inferior goods and normal goods. Normal goods have a positive
income elasticity of demand; as incomes rise, more goods are demanded at each
price level.
Normal goods whose income elasticity of demand is between zero and one are
typically referred to as necessity goods, which are products and services that
consumers will buy regardless of changes in their income levels. Examples of
necessity goods and services include tobacco products, haircuts, water, and
electricity.
As income rises, the proportion of total consumer expenditures on necessity goods
typically declines. Inferior goods have a negative income elasticity of demand; as
consumers' income rises, they buy fewer inferior goods. A typical example of such
type of product is margarine, which is much cheaper than butter.

Luxury goods represent normal goods associated with income elasticities of

demand greater than one. Consumers will buy proportionately more of a particular
good compared to a percentage change in their income. Consumer discretionary
products such as premium cars, boats, and jewelry represent luxury products that
tend to be very sensitive to changes in consumer income. When a business cycle
turns downward, demand for consumer discretionary goods tends to drop as
workers become unemployed.

Basically, a negative income elasticity of demand is linked with inferior goods,

meaning rising incomes will lead to a drop in demand and may mean changes to
luxury goods. A positive income elasticity of demand is linked with normal goods.
In this case, a rise in income will lead to a rise in demand.
 C. CROSS PRICE ELASTICITY OF DEMAND

Cross price elasticity (XED) Measures responsiveness of demand for good X

following a
change in the price of a related good Y.

•SUBSTITUTES:
Substitute is products in competitive demand.
With substitutes, an increase in the price of one good (Ceterisparibus) will lead
to an increase in the demand for arrival product.

The value of XED for two substitutes is always positive.

•COMPLEMENTS:
Compliments are product in joint demand.
A fall in the price of one product causes an increase in demand for the
complementary product.
The value of XED for two complements is always negative.

Cross Price Elasticity Of Demand (XED) Calculations

Changing prices and demand for Dr. Beats Headphones

Beats Studio Headphones retail at approximately £200 per unit. Following a

chance in price of the headphones (An increase of £20), there is an increase
demand for a rival brand of headphones by 5%.

What is the XED of this price change?

•% Change in demand of Y=5%.
•% Change in price of X=10%.
• Coefficient of PED=+0.5.
• The two goods are fairly weak substitutes products.
Understanding the coefficient of cross price elasticity
The strong the relationships between two products, the higher are the co-efficient
of cross-price elasticity of demand.
SUBSTITUTES:
Close substitutes have a strongly positive cross price elasticity of demand i.e. a
small change and relative price causes a big switch in customer demand.
COMPLEMENTS:
When them is a strong complementary relationship, the cross elasticity will be
highly negative.
UNRELATED PRODUCTS:
Unrelated products have zero cross elasticity e.g. the effect of changes in taxi pares
on the market demand for cheese!

Cross Price Elasticity of Demand-Substitutes

Close substitutes:
A small rise in price of X causes large rise in demand for Y

Weak Substitutes:
A large rise in price of S lead to small increase in demand for T.
Cross Price Elasticity of Demand-Complements

Close complements:
As small fall in price of A causes a large rise in demand for B.

Weak Complements:
A large drop in price of E causes only small rise in demand for F.

Cross Price Elasticity-Cinema Ticket Prices

Cinema ticket prices are rising but is £6-£10 still a relatively low price for an
evening’s entertainment?

Total UK Cinema admission remains roughly stable, with 166m admission in

2013.

D. Price Elasticity of Supply

The change in the quantity supplied of a product due to a change in its price is known as
Price elasticity of supply.

Kinds of Price Elasticity Of supply

1) Perfectly elastic supply

When the supply for a product change – increases or decreases even when there is
no change in price, it is known as perfect elastic supply.

Perfectly elastic supply curve

P s s
R
I
C
E
2) Relatively elastic supply

When the proportionate change in supply is more than the proportionate changes in
price, it is known as relatively elastic supply

3) Elasticity of supply equal to utility

When the proportionate change in supply is equal to proportionate changes in price,

it is known as unitary elastic supply

4) Relatively inelastic supply

When the proportionate change in supply is less than the proportionate changes in
price, it is known as relatively inelastic supply
5) Perfectly inelastic supply

When there is no change in the quantity supplied with the change in its price, it is
perfectly inelastic supply

Measurement of Price Elasticity Of supply

There are two methods like:

1. Percentage method or proportionate

Method

(Es) = % Change in Quantity Supplied

% Change in Price
ES = ∆Q/ ∆P*P/Q

∆Q= change in quantity supplied.

∆P= change in price
Q= initial quantity supplied.
P= initial price of the good

2. Geometric method or point method

Es= Difference b/w Qty and intersect on X axis
Difference between Qty and origin

EXAMPLE

• Price of a good falls from Rs.15 to Rs.10 and

The supply decreases from 100 units to 50
Units. Calculate Es.

Q=100 P= 15
Q1=50 P1=10
 • Es= P/Q*∆Q/∆P = 15/100*50/5 = 1.5
• Es> 1, it is a case of elastic sup

(5) Factors Affecting Price Elasticity Of supply

1.) Time Factor

1. Short period - relatively less elastic
2. Long period – more elastic
.2.) Nature of the commodity
1. Perishable goods – relatively less elastic
2. Durable goods – elastic supply
3.) Technique of production
1. Complex technique - inelastic
2. Simple technique – elastic
.
4.) NATURE OF INPUTS USED
1. Commonly used factors – elastic
2. Specialized factors –inelastic
5.) Future price expectation
1. Price increase- inelastic
2. Price decrease – elastic
. Risk Taking
1. Willing to take risk- more elastic
2. Unwilling to take risk- less elastic

Six Practical Importance of the Concept of Price Elasticity Of supply

• The concept is helpful in taking Business Decisions

• Importance of the concept in formatting Tax Policy of the government

• For determining the rewards of the Factors of Production

• To determine the Terms of Trades between the Two Countries