Elasticity

Elasticity-the extent to which buyers and sellers respond to a change in market condition.
There are 4 types of elasticity:

1)Price elasticity of demand (PED):the responsiveness of the quantity demanded to a change in the price of the product.
PED is measured by the following formula:
PED=% change in quantity demended/% change in price
Example: suppose a tour operator sells 5.000 holidays per month to Majorka for a price of 400 pounds.When the price is increased to 440 pounds, demand falls to 4000 holidays per month. So,

PED= -1000/5000 divided by 40/400 multiply to 100% = -20/10 = -2
The estimate of -2 indicates that the demand for holidays is responsive to a change in the price of these holidays. This known as a price elastic or price sensitive situation.
Not all products we buy are very responsive to a change in their price.This is price inelastic or price insensitive,indicating that the quantity demanded is not responsive to a change in price.So:

Price elastic:where the percentage change in the quantity demanded is sensitive to a change in price.
Price inelastic: where the percentage change in the quantity demanded is insensitive to a change in price.
If PED>1 - elastic, if PED<1 red="1">
What determines the price elasticity of demand for a product or group of products?
There are three main determinants:

• The availability and closeness of substitutes

A substitute is the alternative to a particular product.The greater the number of substitutes and the greater their closeness to a given product, then the likelihood is that such product will be price elastic.

• The relative expence of the product with respect to income.

If a product takes up a very small proportion of a person`s income,then doubling in the price will not result in much change in the quantity demanded.In such situation demand is price inelastic.(Examples: bus fares,newspapers,cheap food).
Where a product takes up a larger proportion of income (a holiday or eating out),then it is more likely that demand will be more sensitive to a change in price and so will be more price elastic.A possible exception is the case of habit-forming items, such as cigarettes and certain types of alcohol.

• Time

In the short term, most consumers find it difficult to alter their spending habits. This means they are quit likely to continue to purchase a product despite a price increase.Over time, as consumers find out more about possible substitutes, demand for a product is likely to become more price elastic.

2)Income elasticity of the demand (YED): the responsiveness of demand to a change in income.
Formula: YED = % change in quantity demanded/% change in income
Most products have a positive income elasticity of demand and are known as normal good. This means that, as real disposable income increases, demand for this product will also increase.
The extent of the response of demand to the change in income can vary:

• where the estimate of income elasticity of demand is less than 1. For such a product, demand is said to be income inelastic.
• where the estimate of income elasticity of demand is greater than 1.For such a product, demand is said to be income elastic.

Normal goods: goods with a positive income elasticity of demand.
Income inelastic: goods for which a change in income produces a less than proportionate change in demand.
Income elastic: goods for which a change in income produces a greater proportionate change in demand.
A small number of products have a negative income elasticity of demand.There are known as inferior goods.
Inferior goods: goods for which an increase in income leads to a fall in demand.
Normal goods have a positive YED.
Inferior goods have a negative YED.

Cross elasticity of demand (XED):the responsiveness of demand for one product in relation to a change in the price of another product.
Formula: XED= % change in quantity demanded of product A/% change in price of product B.

• A positive estimate indicates that the two products are substitutes.A negative estimate means that they are complements.A zero estimates means there is no particular relationship.
• The size of the cross elasticity of demand indicates the strength of the relationship between a change in the price of one product and a change in demand for another product.Where products are good or close substitutes, the value of the cross elasticity of demand will be higher than if they are only modest substitutes.Similarly, for complements, a high value of cross elasticity of demand is indicative of products with a high degree of complementary.

Substitutes have a positive XED
Complements have a negative XED

Price elasticity of supply (PES): the responsiveness of the quantity supplied to a change in the price of the product.
Formula: PES= % change in quantity supplied/% change in price.
Price elasticity of supply indicates how much additional supply a producer is willing to provide for the market following a change in price of the product.
The size of the price elasticity of supply can take the following values:

• between 0 and 1.This means that the elasticity of supply is inelastic.
• greater than 1.In this case supply is elastic.
• equal to 1.Here the change in price causes an exactly proportional change in quantity supplied.

So, what determines the price elasticity of supply?There are three main factors:

• Availability of stock of the product.
• Availability of factor of production.
• Time period