BAC- 01 Importance of

Understanding Elasticity

of Demand, Supply,

Cross-price and Income

 What is the importance of understanding Elasticity of demand, supply, cross-price and
income? And how will I relate these terms as a BSBA Financial Management student? First, let us
identify the definition of Elasticity. Elasticity is used to measure the change in the behavior of
buyers and sellers in response to a change in price for a good or service (Kenton, 2021). It is a
significant economic indicator of how buyers and sellers react to shifts and shows how much of
an item or service consumers will purchase when prices rise or fall. By deeply understanding the
concept of elasticity helps companies to establish the most profitable prices for their items.
Approximately, concepts that initially seem confusing can be explained by the idea of elasticity.

The elasticity of demand, also called price elasticity, pertains to the way people react to price
changes (Suttle, 2017). When a factor's demand is inelastic, its price will be high, and when it is
elastic, its price will be low. It shows the responsiveness of the products quantity demanded to
changes in one of the factors that influence demand such as price of the commodity, prices of
related commodities, and consumer’s income. Simply knowing the elasticity of demand has
several advantages. First, one may choose pricing methods in a well-informed manner to
maximize profit by having a thorough comprehension in the elasticity of demand. Second,
knowing the elasticity of demand can help for establishing the output level in order to make
production profitable. And third, it can be used by government to evaluate the best way to tax
commodities.

On the other hand, elasticity of supply, also referred as the price elasticity of supply, measures
a company’s ability to increase or decrease production in response to a price change. It helps to
determine the ability of the company to react and produce supplies rapidly and efficiently as the
price changes. Having an understanding in terms of supply’s elasticity helps companies to find
when it is profitable to supply goods. As a result, the elasticity of supply has significant effects on
markets.

Cross price and income elasticity conveys vital information about the goods. We determine
whether goods are complements or substitutes based on cross price elasticity, while the normal
and inferior goods are related to income elasticity.

The cross price elasticity measures the responsiveness of consumer’s purchases of one good
to a change in the price of a different good (a substitute or a complement). It is important tool
that can be used with relates to market competitions especially for small business owners wanting
to diversify their present product or service offering or who are entering a new industry. By
understanding this elasticity can give an accurate number to illustrate how a price increase or
drop may effect demand for a replacement or complementary good or service. While, income
elasticity measures the responsiveness of consumers to a change in their incomes. Understanding
this elasticity makes it easier to distinguish between essential and non-essential goods. It aids
businesses market strategy in determining what products to manufacture in relation to the
purchasing power and income of consumers.

 Finance also plays a major function in an enterprise so it is necessary to understand these

kind of terms. As a business administration student that is currently taking up financial
management major, studying this topic is necessary. Financial management includes a role to
plan for the future growth and direction of the firm and to maximize the long-run value of the
firm’s equity shares. The elasticity of demand, supply, cross-price and income are tools in able
for a company to identify the strategies that will be used with relates to profit maximization. The
course that I am taking up and these terms are exactly related to each other. They are both related
because they share the same purpose which the decision making. These terms gives me a lot of
knowledge in the behavior of the market, and what are the steps that I can do as a financial
manager in the future.

Rian Kayle R. Esperanza

BSBS-FM 2B
References:

Definition of Elasticity of Supply

https://www.higherrockeducation.org/glossary-of-terms/elasticity-of-supply

Concept of elasticity of supply

https://www.economicshelp.org/blog/154526/economics/the-importance-of-elasticity-of-
supply/#:~:text=The%20elasticity%20of%20supply%20measures,price%20leads%20to%20higher
%20supply.

Definition of Cross price and income elasticity

https://www.khanacademy.org/economics-finance-domain/microeconomics/elasticity-
tutorial/income-elasticity-of-demand/a/lesson-overview-cross-price-elasticity-and-income-
elasticity-of-demand

Elasticity
https://study.com/academy/lesson/what-is-elasticity-in-economics-definition-theory-
formula.html