Part 1- Introduction The report contains the...
Microeconomic concept of elasticity
Quite a crucial topic in Microeconomics, the responsiveness of a product or service towards its price (or other market variables) is known as the concept of elasticity in economics. In the laymen terms, it is that change which is observed in the consumption, of supply of a product which is consequential to the change in market condition, and those conditions can be anything, ranging from the price of the commodity when talking about the consumption, to the government policies when talking about production and supply. There are two types of elasticity measurements in microeconomics, because of the fact that in the market, only two factors exist, namely demand and the supply, so elasticity is also measured only on these two factors, Elasticity of demand and the elasticity of supply.
Speaking in numbers, elasticity of the demand and the supply is measured as the change in the quantity demanded or supplied in comparison to the change in market variable (for example change in the price). This can be further elaborated as- Price elasticity of demand will measure the change in the demand of a commodity upon a decrease or an increase in the price. Theory of demand and Theory of supply play the entire role here as these two theories determine whether the supply or demand will increase upon an increased or decrease in the price (Theory of Demand and Supply). Price in this case was the variable input.
Let us consider an example to clarify this concept.
The demand of a commodity falls by 12 percent consequential to a 10 percent increase in the price, and the supply is increased by 6 percent, price elasticity of demand in this case will be measured by dividing the change in the percentage demanded by the percentage change in its price, and elasticity of supply will be measure by dividing percentage change in supply, by the percentage change in the price.
Change in demand = 12% Change in price = 10% Elasticity of demand = 12/10 = 1.2
Change in Supply = 0.6% Change in price = 10% Elasticity of supply = 0.6/10 = 0.06
The thought is to calculate how responsive a product is to diverse market variables (usually price). if price of the merchandise is not a factor which incites the consumer to buy, a minor change in the price will not be significant enough to cause a shift in the demand, thus the product will be regarded as inelastic, while products which are responsive to the price will show a high flexibility even at a slight change in the price.
A commodity which has an flexibility over 1 is regarded as elastic and below one is termed as inelastic and equal to one is called unit elastic
Foremost being the price, there are number of other factors which affect the flexibility of demand and supply. This is illustrated in the example above, second being the availability of a substitute product. When a product has a alternative product available in the market, its elasticity is elevated because a slight rise in the price and the consumers will shift to the available substitute. Necessary good show relatively less elasticity to price and availability of substitute products, as compared to luxury goods because of the fact that their consumption is essential, and will continue regardless to a price change.