Determinants of Price Elasticity of Supply

6 Key excerpts on "Determinants of Price Elasticity of Supply"

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  eBook - ePub

  Principles of Agricultural Economics

  • Andrew Barkley, Paul W. Barkley(Authors)
  • 2016(Publication Date)
  • Routledge

    (Publisher)

  ceteris paribus ). Only the price and quantity supplied of a good can vary. The market supply curve provides information about how a market economy functions. The next section expands and explains that information.

  8.2 The elasticity of supply

  The profit-maximizing behavior of business firms leads to a positive (upward-sloping) relationship between the price and quantity supplied of a good. The rate of change in one variable in response to a change in the other variable is of critical importance. It comes down to the question, “How much will quantity supplied increase (decrease) for a given increase (decrease) in the price?” The term Elasticity describes this relationship, and understanding the relationship is important to understanding how a market economy functions.

  8.2.1 Elasticity defined

  Elasticity is a measure of the responsiveness of one variable to a small change in another variable.

  • Elasticity = the percentage change in one economic variable in response to a percentage change in another economic variable.

  The elasticity of supply measures how quantity supplied changes when the price of a good increases by one percent:

  • Elasticity of Supply = the percentage change in the quantity supplied in response to a percentage increase in price.

  Mathematically, the elasticity of supply (Es ) is given by:

  (8.5)  Es = (% change in Qs )/(% change in P) = %ΔQs /%ΔP.

  8.2.2 Elasticity classifications

  The formula Es = %ΔQs /%ΔP shows that the price elasticity of supply is the responsiveness (measured by the percentage change) in quantity supplied, given a one percent change in the good’s own price.

  The price elasticity of supply measures the movements along a supply curve. A hypothetical example of the supply curve for bread in New York City appears in Figure 8.4 . The degrees of responsiveness of producers to price changes fall into three categories: (1) Inelastic Supply , (2) Elastic Supply , and (3) Unitary Elastic Supply

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  Quantitative Techniques for Competition and Antitrust Analysis

  • Peter Davis, Eliana Garcés(Authors)
  • 2009(Publication Date)
  • Princeton University Press

    (Publisher)

  15,000 cars would be at most 1,000. On the other hand, the same total income divided more equally could certainly generate sales of more than 1,000. (For recent work, see, for example, Lewbel (2003) and references therein.)

  1.1.2 Demand Elasticities

  Elasticities in general, and demand elasticities in particular, turn out to be very important for lots of areas of competition policy. The reason is that the “price elasticity of demand” provides us with a unit-free measure of the consumer demand response to a price increase.7 The way in which demand changes when prices go up will evidently be important for firms when setting prices to maximize profits and that fact makes demand elasticities an essential part of, for example, merger simulation models.

  1.1.2.1 Definition

  The most useful measurement of the consumer sensitivity to changes in prices is the “own-price” elasticity of demand. As the name suggests, the own-price elasticity of demand measures the sensitivity of demand to a change in the good’s own-price and is defined as

  The demand elasticity expresses the percentage change in quantity that results from a 1% change in prices. Alfred Marshall introduced elasticities to economics and noted that one of their great properties is that they are unit free, unlike prices which are measured in currency (e.g., euros per unit) and quantities (sales volumes) which are measured in a unit of quantity per period, e.g., kilograms per year. In our example in figure 1.1 the demand elasticity for a price increase of 10 leading to a quantity decrease of 5 from the baseline position, where P = 60 and Q = 20, is

  ηjj

  = (−5/20)/(10/60) = −1.5.

  For very small variations in prices, the demand elasticity can be expressed by using the slope of the demand curve times the ratio of prices to quantities. A mathematical result establishes that this can also be written as the derivative with respect to the logarithm of price of the log transformation of demand curve:

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  Agricultural Product Prices

  • William G. Tomek, Harry M. Kaiser(Authors)
  • 2014(Publication Date)
  • Cornell University Press

    (Publisher)

  The concept of a demand function or a demand schedule was discussed in Chapter 2. It provides a description of the relationship between price and the quantity buyers are willing and able to buy, other factors held constant. Price theory suggests an inverse relationship between price and quantity, but the inverse relationship by itself says nothing about the responsiveness of quantity demanded to a price change. This responsiveness is likely to vary from product to product. It is logical to think that the quantity of salt purchased is not very responsive to changes in the price of salt, while on the other hand, the quantity of grapes purchased is relatively more responsive to a change in the price of grapes. From the perspective of consumers, grapes have more substitutes than salt.

  An explicit demand curve can be defined by an algebraic equation, which in practice must be estimated from available data. The quantity variable is normally expressed in physical units, while price is expressed in monetary terms per physical unit. But since different units of measurement are often employed (bushels, pounds, kilograms), it is difficult to make direct comparisons from the equations of the impact a given change in price will have on different products. To facilitate comparisons, economists frequently make use of percentage relationships, which are independent of the size of units used to measure price and quantity. The most common of these percentage relationships is the own-price elasticity of demand, which is a ratio that expresses the percentage change in quantity demanded associated with a given percentage change in price.

  Price elasticity is defined for a point on the demand curve, and hence for most demand functions, the magnitude of the elasticity coefficient varies along the function. Let d equal a very small change, then a mathematical definition of elasticity for product i is

  This equation is merely a way to state the percentage change in Q relative to the percentage change in P, evaluated at a point Pi ,Qi . Note, the elasticity definition can be rewritten as (dQi /dPi )(Pi /Qi ), where dQi /dPi is defined as the first derivative of the demand function Qi = Di (Pi ). Thus, in principle, if one knows dQi /dPi , then the elasticity can be evaluated at particular values of Pi and Qi that are on the function. In empirical analyses, a common point to use is the arithmetic means of Pi and Qi .

  An alternative equation for defining price elasticity is the arc or average formula

  The subscripts now represent two different points on a demand curve. The arc equation is mainly a device for computing an elasticity at an average between two points—not the average of the elasticities on the arc between the points. The smaller the arc or segment, the more nearly the elasticities computed from the arc and point formulas approach each other. Remember, elasticity is strictly defined only with respect to a particular point and, hence, will change as the point is varied.

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  Media Economics

  Applying Economics to New and Traditional Media

  • Colin Hoskins, Stuart M. McFadyen, Adam Finn(Authors)
  • 2004(Publication Date)
  • SAGE Publications, Inc

    (Publisher)

  2

  Demand and Supply

  P rices play a central role in resource allocation. In this chapter, we examine how the quantity demanded and quantity supplied of a product depend on its market price and how the interaction of demand and supply actually determines this price. We look at the sensitivity of quantity demanded and supplied to price, what is termed the price elasticity of demand and the price elasticity of supply . Aspects of demand, supply, and elasticity for media goods and services are examined.

  This chapter should provide you with an understanding of the economic concepts necessary to answer the following media-related questions: How do we know that many estimates of the losses suffered by the music and video industries as a result of piracy are grossly exaggerated? Why is the quantity of telephone calls demanded more sensitive to price the greater the distance of the call? Why did a price cut by The Times newspaper in the United Kingdom result in a bigger increase in daily circulation 9 months later than it did 2 months later? What can we deduce about Universal’s expectations of increased sales when they cut the price of music CDs by 38% in 2003? Why did some Hollywood studios cut the price of movie videos for home use from around $80 to around $25 in the late 1980s? Why did the discovery that the quantity of television advertising demanded is relatively insensitive to changes in the price of advertising spots lead the Peacock Committee to recommend against permitting advertising on the British Broadcasting Corporation (BBC)? Why did Sprint Canada, which initiated a C$20 per household per month maximum for off-peak long distance calls within Canada, subsequently amend this to add a C$0.10 per minute charge on calls after 800 minutes of calls had been logged in the month? Why did its competitors, Bell Canada and AT&T, not follow suit?

  2.1 Demand

  The market demand for a good or service is different from individual demand. Individual demand is how much one person or household wishes to buy. Market demand is the total amount all people in the market wish to purchase and is the sum of the demands by individuals. In this chapter, we will concentrate on market demand. Demand is not just a want; it concerns what will actually be bought at different prices and hence is a wish backed by willingness and ability to pay. Buying a product has an opportunity cost, sacrificing consumption of another good that could be bought instead. Thus wanting or even “needing” a good does not constitute demand unless this sacrifice of the next best alternative is acceptable.

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  Housing: The Essential Foundations

  • Dr Paul Balchin, Paul Balchin, Maureen Rhoden(Authors)
  • 2002(Publication Date)
  • Routledge

    (Publisher)

  1 ) would cause a rise in equilibrium rents. Some former tenants would now see owner-occupation as a better alternative and some (relatively small) shift to the right of demand for owner-occupied housing would occur, putting some downward pressure on equilibrium price. However, since these former privately rented houses would not actually disappear but would most likely be sold for owner-occupation, there would also be a shift right of the supply of owner-occupied housing, putting downward pressure on equilibrium price in this sector.

  Figure 2.7 Shifts in demand and supply

  Figure 2.8 The long-run supply curve for an industry

  PRICE, INCOME AND SUPPLY ELASTICITIES

  From our previous analysis, we know that price influences both the quantity consumers demand and the quantity producers are willing to supply. The quantitative effect on demand or supply may range from quite small to very large. The economic term to describe such responsiveness is elasticity. A high degree of elasticity implies a high level of responsiveness and vice versa.

  Price elasticity of demand

  This represents a measure of the responsiveness of demand to changes in the price of a commodity, as we move along a demand curve. It is defined as follows, where Ed stands for elasticity of demand.

  Figure 2.9 Demand and supply in the housing market

  For example, if a 10 per cent rise in price results in a 20 per cent fall in quantity demanded, the value of elasticity can be calculated as:

  The possible values of Ed vary from zero to (-) infinity. Examples of elastic and inelastic demand curves are given in Figure 2.10 . Figure 2.10a shows an inelastic demand curve. A fall in price from P

  0

  to P

  1

  causes a proportionately smaller rise in quantity demanded (q

  0

  to q

  1

  ). A rise in price (P

  1

  to P

  0

  ) would have produced a proportionately smaller fall in quantity demanded (q

  1

  to q

  0

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  eBook - ePub

  Organisations and the Business Environment

  • Tom Craig, David Campbell(Authors)
  • 2012(Publication Date)
  • Routledge

    (Publisher)

  Supply and Demand DOI: 10.4324/9780080454603-17

  Learning Objectives

  After studying this chapter, students should be able to describe:

  • the features and determinants of demand;
  • what is meant by the demand schedule and the demand curve;
  • the features and determinants of supply;
  • what is meant by the supply schedule and the supply curve;
  • the mechanisms of price determination and disequilibrium;
  • the principles of price and income elasticities of demand;
  • the principles of cross elasticity of demand;
  • the features of factor markets, particularly the labour market.

  17.1 Demand

  Demand and Effective Demand

  Whenever we express an interest in purchasing a good or service, we are indicating a demand. Note though, that it is possible to demand a product without actually buying it. You may demand a new motorcar, but for various reasons (e.g. poverty), you are unable to express your demand in the form of a purchase. It is for this reason that economists distinguish desire for a product with its effective demand. Producers of goods and services are less concerned with how badly you desire their products, and more with how many you will actually buy and at what price.

  Effective demand, as distinct from demand, has three components:

  • the actual quantity demanded of a good or service,
  • the time period over which the quantity is demanded,
  • the price at which the quantity will be demanded over the time period.

  Effective demand thus takes into account the customer’s ability to buy, not just the desire – however intense that may be. We may say, therefore, that the total demand for product A is 10,000 units a month if the price is 45 pennies per unit. Thus all three components must be in place before the demand can be said to be effective.

  The Determinants of Demand

  In seeking to answer the question why

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