SUPPLY

Supply is the willingness and ability of

producers to make a specific quantity of
output available to consumers at a particular
price over a given period of time.

Law of supply
A decrease in the price of a good, all

other things held constant, will cause a

decrease in the quantity supplied of the
good.
An increase in the price of a good, all
other things held constant, will cause an
increase in the quantity supplied of the
good.

Supply Determinants
Sx = F( Px , Py, Pz,;P,O,T)

Sx

= Amount of good x supplied

Px

=
Py,Pz

market
P
o
T

Price of
=
=

good x

Prices of other goods in the

Prices of factors of production

= Objective of the producer

= State of technology

Factors on which supply depends

Important shift factors of supply are

Changes in the prices of inputs used in production of a good
Changes in technology
Changes in suppliers expectations
Changes in taxes and subsidies
Each of these shift factors will cause a shift in supply, whereas a
change in price causes a movement along the supply curve.
The major variables other than price are
Nature of the commodity
Limited supply of inputs
Events beyond human control like good/bad harvest, weather
conditions and natural disasters like floods.
Government restriction on quantity to be produced .

Elasticity of supply

It is defined as the ratio of percentage change in quantity demanded and the

percentage change change in the price of the commodity.

Quantity
Change
in price
Es = change
in quantity
Price

Elasticity
The responsiveness of one variable to
changes in another
When price rises, what happens
to demand?
Demand falls
BUT!
How much does demand fall?

Elasticity
If price rises by 10% - what happens to
demand?
We know demand will fall
By more than 10%?
By less than 10%?
Elasticity measures the extent to which
demand will change

Elasticity . . .
is a measure of how much buyers
and sellers respond to changes in market
conditions
allows us to analyze supply and
demand with greater precision.
Journal Question-Name 3 necessities
and 3 luxuries that you would buy.

Determinants of Elasticity

Time period the longer the time under

consideration the more elastic a good is likely to be
Number and closeness of substitutes
the greater the number of substitutes,
the more elastic
The proportion of income taken up by the
product the smaller the proportion the more
inelastic
Luxury or Necessity - for example,
addictive drugs

Types of Elasticity

Price elasticity of demand

Income elasticity of demand
Cross elasticity
Promotional or Advertisemsent

Measurement of Elasticity :

POINT METHOD
ARC METHOD

Point Method
Point elasticity: Elasticity measured at a
given point of a linear demand (or a
supply) curve.

dQ P1
P =
x
dP Q1

Arc Method
Arc elasticity: Elasticity which is
measured over a discrete interval of a
demand (or a supply) curve.

Q2 Q1
P2 P1
Ep

(Q1 Q2 ) / 2 ( P1 P2 ) / 2
Mid Point
Formula

Question 2.
A firm increases the price of product A, from
50p to 60p, demand falls from 1000 units a
week, to 900 units a week. What is the Price
elasticity of demand of the product?
A. 2
B. 1.5
C. 0.5

 Ed > 1 elastic demand (very responsive

to price changes).
Ed < 1 inelastic demand (not very
sensitive to prices).
Ed = 1 unitary elastic (ratio of %s = 1).

Price Elasticity of Demand

Price elasticity of demand is the

percentage change in quantity demanded
given a percent change in the price.

It is a measure of how much the quantity

demanded of a good responds to a
change in the price of that good.

Computing the Price Elasticity

of Demand
The price elasticity of demand is computed
as the percentage change in the quantity
demanded divided by the percentage
change in price.
Price Elasticity =
Of Demand

Percentage Change in Qd
Percentage Change in Price

Determinants of
Price Elasticity of Demand

Necessities versus Luxuries

Availability of Close Substitutes

Time Horizon

Weightage in total consumption

Range of usage of good .

Perfectly Elasticity of Demand

x axis = quantity demanded

= y axis = price

1
2
In this case, price reduction is not required to increase the quantity
demand.
=
The producers need not concentrate on price reduction
activities to improve the sales if his good comes under the perfectly
elasticity of demand.

Perfectly Inelasticity of Demand

y
P

P
P1

E=0
X= units of goods demand.
Y= price of the commodity

In this case, even though the price of commodity decreases,

the demand remains the same. = 0
The producers need not increase or decrease the price of the
commodity to bring change in demand .

Unitary Elasticity of Demand

E= 1

P
P1

X= units of goods demand.

Y= price of the commodity

1
0
This is a very rare phenomenon that occurs in a business where
the demand increases equally with the increase in price.

Relatively Elasticity of Demand

E>1
P

P1

P
D

X= units of goods demand.

Y= price of the commodity

x
1

ere is a minimum reduction in price and

e demand increases rapidly. So a small

ange in price increases the quantity

manded to large extent to a producer .

:Cell Phones ,Gold.

Relatively Inelasticity of Demand

y
E<1
P

P1

P
X= units of goods demand.
Y= price of the commodity

x 0x

1
Even though there is huge decrease in price, the quantity demanded
increase only a little.
E.g.: Inferior Goods

Example:
P0 = 8

P1 = 7

Q0 = 40

Q1 = 48

Step 1: Q = 48 - 40 = 8
P = 7 - 8 = -1
Step 2: Use the formula for Ed.

Step 3:
Ed = (Qd / P) * P0 / Q0
= (8 /-1) * (8/40) = - 1.6

Step 4:
This means that for every 1 % change in
price that there is a 1.6 % change in
quantity demanded in the opposite
direction.

Income Elasticity
Income Elasticity of Demand

Income elasticity of demand measures

how much the quantity demanded of a
good responds to a change in
consumers income.
It is computed as the percentage
change in the quantity demanded
divided by the percentage change in
income.

Computing Income Elasticity

Income
Elasticity
of Demand

Percentage Change
in Quantity
Demanded
Percentage Change
in Income

Income Elasticity
- Types of Goods Essential Income Elasticity is positive.
Elasticity is less than one (Ey <1)
Comforts
Elasticity equal to unity (Ey =1)
Income Elasticity is equal to unity .

Luxuries
Elasticity is greater than unity (Ey>1)

Income Elasticity of Demand

Normal goods are divided into luxuries
and necessities.
Normal Good demand rises as income
rises and vice versa

YeD mantra
+ = normal
- = inferior!

Income Elasticity of Demand

Luxuries

are goods that have an income

elasticity greater than one.

Their

percentage increase in demand is

greater than the percentage increase in
income.

Income Elasticity of Demand

Inferior goods are those whose
consumption decreases when income
increases.
Inferior goods have income elasticities
less than zero.

Income Elasticity of Demand:

Normal Good demand rises as income

rises and vice versa

Inferior Good demand falls as income

rises and vice versa

Look out for the sign!

A positive sign (+) denotes a normal good

A negative sign (-) denotes an inferior

good

Positive Income Elastic Demand

Diagram

Negative Income Elasticity

Diagram = Inferior

Zero Income Elasticity

This occurs when a

change in income has
NO effect on the
demand for goods.

A rise of 5% income in
a rich country will
leave the Demand for
toothpaste unchanged!

Negative Income
Elasticity

An increase in income will result in a

decrease in demand.
A decrease in income will result in a
rise in demand.

ALSO known as INFERIOR GOODS

Look for the signs!

NORMAL

GOODS

LUXURY GOODS

BETWEEN 0 & 1
+0.5 +0.9 + 0.1

INFERIOR

GREATER THAN 1
+2 +5 +27

GOODS

CAN BE A DECIMAL OR A VALUE

GREATER THAN 1

Income Elasticity and the

Demand
for
Airline
Travel
Demand for air travel has a positive

income elasticity of demand

The industry is cyclical

During an upturn, demand rises for

business and leisure travel)

During a recession, the demand tails

away

Income elasticity will vary according to the

type of air travel

E.g. difference between low-cost nofrills and higher priced scheduled

services on low-haul flights

Income Elasticity of Demand

for Chocolate
Which country has
Total consumption
USA 0.79
Germany 0.39
United Kingdom 0.44
France 0.60
Japan 0.08
Switzerland 1.06

the sweeter tooth

when it comes to
income elasticity for
chocolate??

Reference: Henri Jason Trends in cocoa and chocolate consumption with

particular reference to developments in the major markets. Malaysian
International Cocoa Conference, Kuala Lumpur, (ICCO, ED(MEM) 686)

USES OF INCOME ELASTICITY

It is useful in demand forecasting ,When a change in personal

income is expected

It avoids over or under production.

It helps to define the good as normal or inferior good

PROBLEMS

A consumer demands 4kgs of sugar when his income is Rs 2,000.

When his income went up to Rs 2,400 ,demand for sugar increased
to 5 kgs . Calculate Ye of demand and state whether it is elastic or
inelastic in nature ?

2) If a consumer s demand for a good increases from 100units to

200 units per week when his income rises from Rs 2000 to Rs
3000,Find income elasticity of demand ?

1.2 , 2

Cross-Price Elasticity
Measures how sensitive DEMAND
for a commodity is to changes in
the price of a substitute or
compliment commodity

Cross- Elasticity of Demand

Cross- elasticity of demand the

percentage change in demand divided by
the percentage change in the price of
another good.

Complements and
Substitutes
Substitutes are goods that can be
used in place of another.
Substitutes have positive cross-price
elasticities.

Complements and Substitutes

Complements are goods that are used in
conjunction with other goods.
Complements have negative cross-price
elasticities.

Let us assume that two commodities X n

Y are related the expression of cross elasticity
of demand would be

E xy = qx py
py qx

Same formula is used for both substitutes and

complementary
goods

For substitutes cross elasticity is positive

For complements cross elasticity is negative

If the goods are non related i.e., neither

substitutes nor compliments C.E.D is zero

Problem
The price of coffee increases from Rs 50per kg to Rs
70 per kg AS A RESULT THE DEMAND FOR TEA
INCREASES FROM 5 Kg to 10 kgs .What is the cross
elasticity of demand of tea for coffee ?

P coffee =Rs 70-Rs 50 = Rs 20

Qtea = 10kg- 5Kg =5Kg
E xy = qTea
.
pCoffee

pCoffee
qTea.

Problem

A and B are rival products .The price of A

decreases from Rs 200 to Rs 150 .The
demand for B decreases from 100units to
80 units .Calculate cross elasticity of
demand ?

Promotional Elasticity
Measures the responsiveness of
demand to changes in advertisements
or promotional expenses .
It is very useful for producers to
calculate the change in sales as a result
of change in advertisement expenditure
.
It depends on stage of products
development .

FORMULA
Ea = S. A

A. S
S = Sales
A= Initial Advertisement cost
S = change in Sales
A = Change in Advertisement cost

Importance of Elasticity
Relationship between changes
in price and total revenue
Importance in determining
what goods to tax (tax revenue)
Importance in analysing time lags in
production
Influences the behaviour of a firm