Definition of elasticity of demand
Elasticity of demand is a measure of how sensitive the quantity demanded for a good or service is to changes in its price. It can be thought of as the percentage change in quantity demanded divided by the percentage change in price. In other words, it measures how much the quantity demanded changes when the price is changed by a certain amount.
Concepts associated with elasticity of demand
The concepts associated with elasticity of demand include: responsiveness to price changes and cross-price elasticity of demand
1. Responsiveness to Price Changes: Elasticity of demand is usually thought to be responsive to changes in prices – that is, consumers will generally buy more quantities if the price for a good or service goes up than if it goes down (assuming that there are no other factors influencing consumption ).
2.Cross-Price Elasticity of Demand: The cross-price elasticity of demand measures how much the quantity demanded for one good or service changes when the price for another good or service is changed. For example, if households have to choose between buying a product that costs $5 and one that costs $10, an increase in the price for the product costing $10 would lead to a decrease in demand for the product costing $5 (since it would now cost more).
Concept of market demand and market supply
Market demand is the total quantity of a good or service that producers are willing to sell at any price.
Market supply is the total quantity of a good or service that producers are willing to sell at any price if they can find someone who will buy it. 3. The diagram below shows the relationship between market demand and market supply.
What determines the elasticity of demand?
Income, substitution possibilities, and price expectations are the main factors that determine the elasticity of demand. Income: The more money people have available to spend on goods and services, the more responsive they will be to changes in prices. Substitution Possibilities: The greater the number of substitutable items consumers can buy at different prices, the less responsive they will be to small changes in price. Price Expectations: When consumers know what others around them are paying for a good or service, they tend to adjust their own behavior based on those prices .
Factors that affect the elasticity of demand
The elasticity of demand is affected by a variety of factors, including:
– Income: The higher the income level, the more responsive consumers will be to price changes.
– Substitution possibilities and prices of related items: Consumers with more choices about what to buy (substitute goods) are less responsive to price changes.
– Price expectations among buyers: When people expect others around them to pay a particular price for a good or service, they are likely to adjust their behavior accordingly. – Time: The more time that passes, the less responsive consumers are to small changes in price.
– Number of buyers: The greater the number of buyers for a good or service, the less responsive they will be to small changes in price. – Preference: The more people prefer a good or service, the less responsive they will be to small changes in price.
Factors that influence the elasticity of demand for goods and services
The following factors can influence the elasticity of demand for goods and services:
– Substitution possibilities: The greater the number of substitutable items available, the less responsive consumers will be to small changes in price.
– Price expectations among buyers: As prices for related items change, so does buyer’s expected price for a good or service. This affects how people respond to pricing changes.
– Time: As time passes, consumers become less responsive to small changes in prices.
– Number of buyers: The more people who want a good or service at any given moment, the less responsive they will be to small changes in price.
– Preference: The more someone prefers a good or service, the less responsive they will be to small changes in price.
Effects of changes in price on demand for a good or service
When prices for a good or service change, demand for the good or service will generally respond in one of three ways:
– Reduced quantity demanded: If buyers expect the price of a good to rise, they are likely to buy less of it when the price does actually increase.
– Increased quantity demanded: This occurs when buyers believe that prices are about to decrease and so purchase more items in anticipation.
– No change in quantity demanded: When there is no expectation among buyers that prices will change, demand remains unchanged.
The law of supply and demand in action
In the market for milk, if the price of milk rises above what the farmer is willing to sell at, demand will decrease and more farmers will begin producing milk in order to meet this increased demand. The law of supply and demand tells us that when there is a shortage (or overabundance) of something in the market, its price will go up (or down).
Negative and positive effects of the law of supply and demand
In a free market, the law of supply and demand works to equilibrium prices, which is where production matches (or exceeds) buyer demand. When there is too much available for sale at an overpriced rate, people are forced to stop buying in order to conserve their limited supplies. This can lead to a sudden decline in prices which isn’t sustainable because it’s taking away money from producers who need that money in order to continue producing. Conversely, when there is too little available for sale at a low price point due to high demand, producers are able to increase production which can lead to a sudden rise in prices because there is more available for sale.
Applications of elasticity of demand
1. The elasticity of demand is used to predict how much change in one’s price will cause a change in the quantity demanded for that good.
2. For example, if you double the price of your product and find that people are only buying half as much, then it can be assumed that their demand for your product is quite elastic (or responsive). If this is true, then you would need to increase the quantity supplied by only 50% in order to maintain equilibrium prices with buyers.
3. Elasticity of demand can also be used to determine how likely someone is to switch to buying a different product if the price of their current product changes. For example, if you hike the price of your product by 50% and find that demand drops by 50%, then it can be assumed that there is little or no elasticity of demand for this particular good (meaning people are unlikely to switch to another product even if prices go up).
Tagged with: CLASS 12TH | economics notes | micro economics | notes | notes class 11 | previous year question paper