B y 'elasticity' economists mean responsiveness. Cutting the price of a product usually attracts more demand for it. But how much more? Increasing people's incomes usually leads them to demand more goods. But how much more, and of which goods?Just as demand responds to price changes, so may supply. If the price of a good rises, suppliers may offer more of it. But how much more?Meet three concepts of elasticity:
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The price elasticity of demand is a measure of how much the demand for a good changes in response to a change in its price (if nothing else changes).
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The income elasticity of demand is a measure of how much the demand for a good -- or for all goods -- changes in response to a change in consumers' incomes.
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The price elasticity of supply is a measure of how much the supply of a good changes in response to a change in its price.
All three have to be qualified by 'if nothing else changes'. When a number of forces operate at once it may be difficult to distinguish the effects of price or income changes from the effects of other causes. Even where other conditions are steady, the demand for some products (bread, butter) is more predictable than the demand for others (ice creams, sports cars) which may respond more to impulse, advertising or the weather. And you will meet other causes for caution in using the con- cept of elasticity. But first, what does it mean and how is it measured? We will illustrate from the price elasticity of demand, which is the measure that gets the most use.
THE PRICE ELASTICITY OF DEMAND
Producers often need to know what relations to expect between prices and the quantities they can sell. They study the past behavior of their markets to find answers to any of the following questions, which are all about the relation between changes in price and changes in quantity demanded:
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Will a price cut increase the volume of sales by enough to increase total revenue? Or by enough to yield the same revenue as before? Or by little enough to reduce total revenue? (You're selling 1000 pounds of carrots a week at $1 a pound for a total $1000. If you halve the price, will consumers buy 3000 lb. for $1500? Or 2000 lb. for the same $1000 as before? Or 1500 lb. for only $750?)
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Will a price increase cut sales by little enough to yield an increase in total revenue? Or by an amount which yields the same revenue as before? Or by an amount which yields less total revenue than before?
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Will an increase in supply push prices down far enough to yield less total revenue than before? Or the same? Or more?
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Will a cut in supply push prices up to a level which yields more total revenue than before? Or the same? Or less?
Many producers are less interested in total revenue than in relations between their sales revenue and their costs of production. Suppose a producer has potential economies of scale. Producing more can cut the unit costs of the product. Will an increased supply cut mar- ket prices by less than it cuts the producer's costs? (Then the producer will be richer.) Or will the increased supply cut market prices by more than it cuts the pro- ducer's costs? (Then one more mousetrap-maker may bite the dust.) Notice that if prices rise further than costs do, or if costs fall further than prices do, it is quite pos- sible for a producer to be better off -- to be making more profit per unit and more total profit -- despite a fall in total revenue.So the question above can be re-stated with reference to profit margins rather than total revenue. Will a high- er volume at a lower price have a bigger effect on rev- enue than on costs? Or a neutral effect? Or a smaller effect? Will a change to a lower volume at a higher price have a bigger effect on revenue than on costs, a neutral effect, or a smaller effect?All those questions call for (among other things) esti- mates of price elasticities of demand. So economists have developed rough ways of naming and measuring them.Classifying elasticity
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If a price cut brings such a big increase in sales that total revenue is greater than before, demand is said to be elastic.
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Publication Information: Book Title: Economics, a New Introduction. Contributors: Hugh Stretton - author. Publisher: UNSW Press. Place of Publication: Sydney, N.S.W.. Publication Year: 1999. Page Number: 271.
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