ELASTICITY In economics, elasticity is the ratio of the percent change in one variable to t he percent change in another variable.

It is a tool for measuring the responsive ness of a function to changes in parameters in a relative way. Commonly analyzed are elasticity of substitution, price and wealth. Elasticity is a popular tool among empiricists because it is independent of units and thus simplifies data an alysis. An "elastic" good is one whose price elasticity of demand has a magnitude greate r than one. Similarly, "unit elastic" and "inelastic" describe goods with price elasticity having a magnitude of one and less than one respectively. Price elasticity of demand is defined as the measure of responsiveness in the qu antity demanded for a commodity as a result of change in price of the same commo dity. It is a measure of how consumers react to a change in price. [1] In other words, it is percentage change in quantity demanded as per the percentage change in price of the same commodity. In economics and business studies, the price el asticity of demand (PED) is a measure of the sensitivity of quantity demanded to changes in price. It is measured as elasticity, that is it measures the relatio nship as the ratio of percentage changes between quantity demanded of a good and changes in its price. In simpler words, demand for a product can be said to be very inelastic if consumers will pay almost any price for the product, and very elastic if consumers will only pay a certain price, or a narrow range of prices, for the product. Inelastic demand means a producer can raise prices without muc h hurting demand for its product, and elastic demand means that consumers are se nsitive to the price at which a product is sold and will not buy it if the price rises by what they consider too much. Drinking water is a good example of a goo d that has inelastic characteristics in that people will pay anything for it (hi gh or low prices with relatively equivalent quantity demanded), so it is not ela stic. On the other hand, demand for sugar is very elastic because as the price o f sugar increases, there are many substitutions which consumers may switch to. A price drop usually results in an increase in the quantity demanded by consumer s (see Giffen good for an exception). The demand for a good is relatively inelas tic when the change in quantity demanded is less than change in price. Goods and services for which no substitutes exist are generally inelastic. Demand for an antibiotic, for example, becomes highly inelastic when it alone can kill an infe ction resistant to all other antibiotics. Rather than die of an infection, patie nts will generally be willing to pay whatever is necessary to acquire enough of the antibiotic to kill the infection. Elastic range When the price elasticity of demand for a good is inelastic ( Ed < 1), the perc entage change in quantity demanded is smaller than that in price. Hence, when th e price is raised, the total revenue of producers rises, and vice versa. When the price elasticity of demand for a good is elastic ( Ed > 1), the percen tage change in quantity demanded is greater than that in price. Hence, when the price is raised, the total revenue of producers falls, and vice versa. When the price elasticity of demand for a good is unit elastic (or unitary elast ic) ( Ed = 1), the percentage change in quantity is equal to that in price. When the price elasticity of demand for a good is perfectly elastic (Ed is undef ined), any increase in the price, no matter how small, will cause demand for the good to drop to zero. Hence, when the price is raised, the total revenue of pro ducers falls to zero. The demand curve is a horizontal straight line. A banknote is the classic example of a perfectly elastic good; nobody would pay 10.01 for a 10 note, yet everyone will pay 9.99 for it. When the price elasticity of demand for a good is perfectly inelastic (Ed = 0), changes in the price do not affect the quantity demanded for the good. The deman d curve is a vertical straight line; this violates the law of demand. An example of a perfectly inelastic good is a human heart for someone who needs a transpla nt; neither increases nor decreases in price affect the quantity demanded (no ma tter what the price, a person will pay for one heart but only one; nobody would buy more than the exact amount of hearts demanded, no matter how low the price i s).

Factors that determine the value of price elasticity of demand 1. Number of close substitutes within the market - The more (and closer) substit utes available in the market the more elastic demand will be in response to a ch ange in price. In this case, the substitution effect will be quite strong. 2. Luxuries and necessities - Necessities tend to have a more inelastic demand c urve, whereas luxury goods and services tend to be more elastic. For example, th e demand for opera tickets is more elastic than the demand for urban rail travel . The demand for vacation air travel is more elastic than the demand for busines s air travel. 3. Percentage of income spent on a good - It may be the case that the smaller th e proportion of income spent taken up with purchasing the good or service the mo re inelastic demand will be. 4. Habit forming goods - Goods such as cigarettes and drugs tend to be inelastic in demand. Preferences are such that habitual consumers of certain products bec ome de-sensitised to price changes. 5. Time period under consideration - Demand tends to be more elastic in the long run rather than in the short run. For example, after the two world oil price sh ocks of the 1970s - the "response" to higher oil prices was modest in the immedi ate period after price increases, but as time passed, people found ways to consu me less petroleum and other oil products. This included measures to get better m ileage from their cars; higher spending on insulation in homes and car pooling f or commuters. The demand for oil became more elastic in the long-run. Income Elasticity In economics, the income elasticity of demand measures the responsiveness of the quantity demanded of a good to the change in the income of the people demanding the good. It is calculated as the ratio of the percent change in quantity deman ded to the percent change in income. For example, if, in response to a 10% incre ase in income, the quantity of a good demanded increased by 20%, the income elas ticity of demand would be 20%/10% = 2. A negative income elasticity of demand is associated with inferior goods; an inc rease in income will lead to a fall in the quantity demanded and may lead to cha nges to more luxurious substitutes. A positive income elasticity of demand is associated with normal goods; an incre ase in income will lead to a rise in the quantity demanded. If income elasticity of demand of a commodity is less than 1, it is a necessity good. If the elastic ity of demand is greater than 1, it is a luxury good or a superior good. A zero income elasticity (or inelastic) demand occurs when an increase in income is not associated with a change in the quantity demanded of a good. These would be sticky goods. Income Elasticity of Demand How sensitive is the demand for a product to a change in the real incomes of con sumers? We use income elasticity of demand to measure this. The results are impo rtant since the values of income elasticity tell us something about the nature o f a product and how it is perceived by consumers. It also affects the extent to which changes in economic growth affect the level and pattern of demand for good s and services. Definition of income elasticity of demand Income elasticity of demand measures the relationship between a change in quanti ty demanded for good X and a change in real income. The formula for calculating income elasticity: % change in demand divided by the % change in income Normal Goods Normal goods have a positive income elasticity of demand so as consumers income r ises, so more is demanded at each price level i.e. there is an outward shift of the demand curve Normal necessities have an income elasticity of demand of between 0 and +1 for e xample, if income increases by 10% and the demand for fresh fruit increases by 4

% then the income elasticity is +0.4. Demand is rising less than proportionately to income. Luxuries have an income elasticity of demand > +1 i.e. the demand rises more tha n proportionate to a change in income for example a 8% increase in income might lead to a 16% rise in the demand for restaurant meals. The income elasticity of demand in this example is +2.0. Demand is highly sensitive to (increases or decr eases in) income. Inferior Goods Inferior goods have a negative income elasticity of demand. Demand falls as inco me rises. Typically inferior goods or services tend to be products where there a re superior goods available if the consumer has the money to be able to buy it. Examples include the demand for cigarettes, low-priced own label foods in superm arkets and the demand for council-owned properties. The income elasticity of demand is usually strongly positive for Fine wines and spirits, high quality chocolates (e.g. Lindt) and luxury holidays overseas. Consumer durables - audio visual equipment, 3G mobile phones and desi gner kitchens. Sports and leisure facilities (including gym membership and sport s clubs). In contrast, income elasticity of demand is lower for Staple food products such as bread, vegetables and frozen foods. Mass transport (bus and rail). Beer and t akeaway pizza! Income elasticity of demand is negative (inferior) for cigarettes and urban bus services. Product ranges: However the income elasticity of demand varies within a product range. For example the Yed for own-label foods in supermarkets is probably less for the high-value finest food ranges that most major supermarkets now offer. You would also expect income elasticity of demand to vary across the vast range of v ehicles for sale in the car industry and also in the holiday industry. Long-term changes: There is a general downward trend in the income elasticity of demand for many products, particularly foodstuffs. One reason for this is that as a society becomes richer, there are changes in consumer perceptions about dif ferent goods and services together with changes in consumer tastes and preferenc es. What might have been considered a luxury good several years ago might now be regarded as a necessity (with a lower income elasticity of demand). Consider the market for foreign travel. A few decades ago, long-distance foreign travel was regarded as a luxury. Now as real price levels have come down and in comes have grown, so millions of consumers are able to fly overseas on short and longer breaks. For many an annual holiday overseas has become a necessity and n ot a discretionary item of spending! Estimates for income elasticity of demand

Product Share of budget (% of household income) Price elasticity of demand (Ped) y of demand (Yed) All Foods 15.1 n/a 0.2 Fruit juices 0.19 -0.55 0.45 Tea 0.19 -0.37 -0.02 Instant coffee 0.17 -0.45 0.16 Margarine 0.03 n/a -0.37 Source: DEFRA www.defra.gov.uk

Income elasticit

The income elasticity of demand for most types of food is pretty low occasionall y negative (e.g. for margarine) and likewise the own price elasticity of demand for most foodstuffs is also inelastic. In other words, the demand for these prod ucts among consumers is not sensitive to changes in the products price or changes in consumer income. How do businesses make use of estimates of income elasticity of demand? Knowledge of income elasticity of demand for different products helps firms pred

ict the effect of a business cycle on sales. All countries experience a business cycle where actual GDP moves up and down in a regular pattern causing booms and slowdowns or perhaps a recession. The business cycle means incomes rise and fal l. Luxury products with high income elasticity see greater sales volatility over th e business cycle than necessities where demand from consumers is less sensitive to changes in the economic cycle The UK economy has enjoyed a period of economic growth over the last twelve year s. So average real incomes have increased, but because of differences in income elasticity of demand, consumer demand for products will have varied greatly over this period. Income elasticity and the pattern of consumer demand Over time we expect to see our real incomes rise. And as we become better off, w e can afford to increase our spending on different goods and services. Clearly w hat is happening to the relative prices of these products will play a key role i n shaping our consumption decisions. But the income elasticity of demand will al so affect the pattern of demand over time. For normal luxury goods, whose income elasticity of demand exceeds +1, as incomes rise, the proportion of a consumers income spent on that product will go up. For normal necessities (income elastici ty of demand is positive but less than 1) and for inferior goods (where the inco me elasticity of demand is negative) then as income rises, the share or proporti on of their budget on these products will fall.

(% 1980 1990 2003 Food 14.5 11.5 9.6 Alcohol & tobacco 7.8 Of which Alcohol 2.1 1.8 Tobacco 6.0 3.3 1.7 Clothing & footwear 8.1 Household goods, etc 5.4 Health 1.5 1.6 1.3 Transport 13.9 15.3 Of which Cars 4.1 5.8 Travel 3.6 3.4 3.1 Of which Air 1.0 1.2 Communications 1.4 1.6 Recreation & culture 7.8 Travel Other, including package holidays Education 1.4 1.1 Restaurants & hotels 12.7 Source: Family Expenditure Survey

5.0 1.8

3.5 4.8 5.2

5.4 14.0 6.5 1.3 3.1 10.0 1.2 12.6

6.0

15.5 2.0 9.3

2.7

4.5

Price Elasticity of Supply In economics, the price elasticity of supply is defined as a numerical measure o

f the responsiveness of the quantity supplied of product (A) to a change in pric e of product (A) alone. It is the measure of the way quantity supplied reacts to a change in price.[1] For example, if, in response to a 10% rise in the price of a good, the quantity supplied increases by 20%, the price elasticity of supply would be 20%/10% = 2. (Case & Fair, 1999: 119). When there is a relatively inelastic supply for the good the coefficient is low; when supply is highly elastic, the coefficient is great. Supply is normally mor e elastic in the long run than in the short run for produced goods, since it is generally assumed that in the long run all factors of production can be utilised to increase supply, wherease in the short run only labor can be increased. Of c ourse goods that have no labor component and are not produced cannot be expanded . Such goods are said to be "fixed" in supply and do not respond to price change s. If the coefficient is exactly one, the good is said to be unitary elastic. The quantity of goods supplied can, in the short term, be different from the amo unt produced, as manufacturers will have stocks which they can build up or run d own. The determinants of the price elasticity of supply are: the existence of the naturally occurring raw materials needed for production; the length of the production process (run-in time); the production spare capacity (the more spare capacity there is in an industry t he easier it should be to increase output if the price goes up); the time period and the factor immobility (the ease of entering the industry); the storage capacity of the merchants (if they have more goods in stock they wil l be able to respond to a change in price more quickly). The Price Elasticity of Supply measures the rate of response of quantity demand due to a price change. If you ve already read The Price Elasticity of Demand and understand it, you may want to just skim this section, as the calculations are similar. (Your course may use the more complicated Arc Price Elasticity of Suppl y formula. If so you ll need to see the article on Arc Elasticity) We calculate the Price Elasticity of Supply by the formula: PEoS = (% Change in Quantity Supplied)/(% Change in Price) Calculating the Price Elasticity of Supply You may be asked "Given the following data, calculate the price elasticity of su pply when the price changes from $9.00 to $10.00" Using the chart on the bottom of the page, I ll walk you through answering this question. First we need to find the data we need. We know that the original price is $9 an d the new price is $10, so we have Price(OLD)=$9 and Price(NEW)=$10. From the ch art we see that the quantity supplied (make sure to look at the supply data, not the demand data) when the price is $9 is 150 and when the price is $10 is 110. Since we re going from $9 to $10, we have QSupply(OLD)=150 and QSupply(NEW)=210, where "QSupply" is short for "Quantity Supplied". So we have: Price(OLD)=9 Price(NEW)=10 QSupply(OLD)=150 QSupply(NEW)=210 To calculate the price elasticity, we need to know what the percentage change in quantity supply is and what the percentage change in price is. It s best to cal culate these one at a time. Calculating the Percentage Change in Quantity Supply The formula used to calculate the percentage change in quantity supplied is: [QSupply(NEW) - QSupply(OLD)] / QSupply(OLD) By filling in the values we wrote down, we get: [210 - 150] / 150 = (60/150) = 0.4 So we note that % Change in Quantity Supplied = 0.4 (This is in decimal terms. I n percentage terms it would be 40%). Now we need to calculate the percentage cha nge in price. Calculating the Percentage Change in Price

Similar to before, the formula used to calculate the percentage change in price is: [Price(NEW) - Price(OLD)] / Price(OLD) By filling in the values we wrote down, we get: [10 - 9] / 9 = (1/9) = 0.1111 We have both the percentage change in quantity supplied and the percentage chang e in price, so we can calculate the price elasticity of supply. Final Step of Calculating the Price Elasticity of Supply We go back to our formula of: PEoS = (% Change in Quantity Supplied)/(% Change in Price) We now fill in the two percentages in this equation using the figures we calcula ted. PEoD = (0.4)/(0.1111) = 3.6 When we analyze price elasticities we re concerned with the absolute value, but here that is not an issue since we have a positive value. We conclude that the p rice elasticity of supply when the price increases from $9 to $10 is 3.6. How Do We Interpret the Price Elasticity of Supply? The price elasticity of supply is used to see how sensitive the supply of a good is to a price change. The higher the price elasticity, the more sensitive produ cers and sellers are to price changes. A very high price elasticity suggests tha t when the price of a good goes up, sellers will supply a great deal less of the good and when the price of that good goes down, sellers will supply a great dea l more. A very low price elasticity implies just the opposite, that changes in p rice have little influence on supply. Often you ll have the follow up question "Is the good price elastic or inelastic between $9 and $10". To answer that, use the following rule of thumb: If PEoS > 1 then Supply is Price Elastic (Supply is sensitive to price changes) If PEoS = 1 then Supply is Unit Elastic If PEoS < 1 then Supply is Price Inelastic (Supply is not sensitive to price cha nges) Recall that we always ignore the negative sign when analyzing price elasticity, so PEoS is always positive. In our case, we calculated the price elasticity of s upply to be 3.6, so our good is price elastic and thus supply is very sensitive to price changes. Price elasticity of supply measures the relationship between change in quantity supplied and a change in price. The formula for price elasticity of supply is: Percentage change in quantity supplied / Percentage change in price The value of elasticity of supply is positive, because an increase in price is l ikely to increase the quantity supplied to the market and vice versa. FACTORS THAT DETERMINE ELASTICITY OF SUPPLY The elasticity of supply depends on the following factors The value of price elasticity of supply is positive, because an increase in pric e is likely to increase the quantity supplied to the market and vice versa. The elasticity of supply depends on the following factors: SPARE CAPACITY How much spare capacity a firm has - if there is plenty of spare capacity, the f irm should be able to increase output quite quickly without a rise in costs and therefore supply will be elastic STOCKS The level of stocks or inventories - if stocks of raw materials, components and finished products are high then the firm is able to respond to a change in deman d quickly by supplying these stocks onto the market - supply will be elastic EASE OF FACTOR SUBSTITUTION Consider the sudden and dramatic increase in demand for petrol canisters during the recent fuel shortage. Could manufacturers of cool-boxes or producers of othe r types of canister have switched their production processes quickly and easily to meet the high demand for fuel containers? If capital and labour resources are occupationally mobile then the elasticity of

supply for a product is likely to be higher than if capital equipment and labou r cannot easily be switched and the production process is fairly inflexible in r esponse to changes in the pattern of demand for goods and services. TIME PERIOD Supply is likely to be more elastic, the longer the time period a firm has to ad just its production. In the short run, the firm may not be able to change its fa ctor inputs. In some agricultural industries the supply is fixed and determined by planting decisions made months before, and climatic conditions, which affect the production, yield. Economists sometimes refer to the momentary time period - a time period that is short enough for supply to be fixed i.e. supply cannot respond at all to a chang e in demand. ILLUSTRATING PRICE ELASTICITY OF SUPPLY When supply is perfectly inelastic, a shift in the demand curve has no effect on the equilibrium quantity supplied onto the market. Examples include the supply of tickets for sports or musical venues, and the short run supply of agricultura l products (where the yield is fixed at harvest time) the elasticity of supply = zero when the supply curve is vertical. When supply is perfectly elastic a firm can supply any amount at the same price. This occurs when the firm can supply at a constant cost per unit and has no cap acity limits to its production. A change in demand alters the equilibrium quanti ty but not the market clearing price. When supply is relatively inelastic a change in demand affects the price more th an the quantity supplied. The reverse is the case when supply is relatively elas tic. A change in demand can be met without a change in market price.