The elasticity of supply and demand. Demand Elasticity Factors

We all know that a fall in prices causes an increase in demand and a decrease in supply. In many cases, the direction of these changes is all that matters. However, in others - it is important to understand their scale and the exact number of units of products that consumers want to buy at a lower price. In order to measure the degree of these changes, and not just their direction, the concept of elasticity of demand is used. The value of this indicator allows you to answer the question to what extent the increase or decrease in price will affect the behavior of consumers and producers.

Demand concept

Economics has come a long way from one of the branches of philosophy to independent science. Objective laws are found to which market changes are subject. This also concerns supply and demand. All things being equal, a rise in price will cause a decrease in the first and an increase in the second. The objective law of supply and demand was formulated by Alfred Marshall in 1890. The market price is set at the intersection of these two indicators on the chart.

Demand is the quantity of goods needed by the actual or potential consumer. He expresses at the same time the desire of the buyer and his financial capabilities. It is characterized by such quantitative parameters as size and volume. In addition to price, demand is influenced by consumer tastes, fashion, people's incomes, the cost of other goods, and the rate of substitution. Salary growth encourages buyers to purchase more products. The increase in the price of products forces consumers to reduce demand. The opposite situation is observed when it comes to Giffen goods. The value of demand for them increases when their price increases.

General information

Economists use the elasticity of supply and demand in order to measure the scale of changes in the behavior of market entities. The value of this indicator is most often determined as the result of dividing the change in the quantity of production by an increase or decrease in price. For example, if an increase in value by 10% led to the fact that buyers began to consume 12% less goods, then the elasticity of demand is 1.2. The resulting result is more than one. This means that the demand in our task is an elastic quantity. Similar is the calculation of the indicator of supply. For example, the price increased by 10%, and the number of units produced increased by 6%. The elasticity of the proposal will be 0.6. The resulting result is less than one. The offer of the product in question is inelastic in price. Thus, such tasks are solved very simply. The elasticity of supply and demand is found by simply dividing the percent change in the quantity of products consumed by buyers and produced by sellers by the difference between the old and new prices.

Definition and concept

In economics, elasticity is the degree of reaction of one indicator to another. Her calculation provides an answer to the manufacturer on three questions:

• If you lower the price of products, how many more units can be sold?
• How will the increase in the cost of goods affect the volume purchased?
• If the market price of products decreases, how will this affect the release of goods?

A variable whose value is greater than one is considered elastic. This means that it responds to changes in other indicators more than proportionally. A variable can be more or less elastic at different points in time. The product may be more sensitive to price or revenue.Elasticity allows you to compare completely different values, since the change in each of them can be expressed as a percentage. Therefore, this concept is perhaps the most important in neoclassical economic theory. It is useful in understanding the effects of indirect taxation, income distribution, consumer choice theory. In practice, elasticity is a linear regression coefficient, where both variables are natural numbers. A major study of the sensitivity of supply and demand for American products was conducted by Hendrick S. Houtacker and Lester D. Taylor.

Demand Elasticity: Formula

Calculation of the indicator is carried out in one action. The most important thing is to express all the source data in one units (most often this is done as a percentage). The result of dividing the difference between the old and new prices by the change in the volume of purchased is the elasticity of demand. The formula indicates two options:

1. Inelastic demand. If the percentage of price changes is greater than the difference between the volumes of purchased goods.
2. Elastic demand. If the percentage of price changes is less than the difference between the volumes of purchased goods.

Practical application

The whole point is that the value of elasticity of demand means how sensitive consumers are to price changes. And this is extremely important information for sellers. High elasticity of demand means that even a small increase in prices will lead to a significant drop in consumption of these products. You can use this property in the other direction. The manufacturer only needs to lower the price a little, and they will start buying a lot more from him. If demand is insensitive to price changes, then consumption can remain unchanged for a long time. In order to remember this, one can compare the elasticity of demand with flexibility. Something is called elastic if it stretches well. The same term characterizes a similar property of supply and demand.

Demand Elasticity Factors

Although supply and demand are important, most studies focus on the latter. What determines its elasticity? The main factor is the availability of substitute goods for consumers. Suppose a gas station decided to raise the price of gas by 10%. Most consumers will simply switch to fuel from other sellers. The elasticity of demand for gas in this case is more than one, so buyers are very sensitive to price changes. The gas station from the example can lose much more than 10%. But suppose that there are no other gasoline sellers in the city, that is, substitute goods are not available to consumers. In this case, the coefficient of elasticity of demand is equal to approximately zero. Motorists will have no choice but to continue to buy more expensive gasoline. Raising the price will only increase the income of the only gas station in the city. Of course, motorists can reduce unnecessary movement around the city or transfer to bicycles, but in any case, in the short and medium term, the decrease in demand for gas will be insignificant.

How much we receive also influences what price changes seem insignificant to us. Thus, the elasticity of demand determines the size of the income of consumers. For example, few compare prices for shoelaces. Their price does not bother most buyers. They spend so little money on them that even doubling their value will not have a significant impact on the family budget. Searching for a cheaper option will take time, the costs of which will not pay off due to the saved 10 rubles. But for companies that produce these shoelaces, every penny is important. Thus, the factors of elasticity of demand also include income. All things being equal, the more expensive a product is for us, the greater its value is the elasticity of demand.

Time is the next factor.If there is more, then the consumer has more opportunities to find substitutes. Suppose the only gas station in the city raised the price of gasoline. At first, residents will continue to buy fuel for their voracious SUVs. But with the purchase of the next car, they can pay attention to less gluttonous models. The more time we have to change our consumer behavior, the higher will be the elasticity of demand.

Graphic image

Changing the elasticity of demand is easy to draw. First you need to draw the standard abscissa and ordinates. The vertical line X will display the quantity of the product, the horizontal Y will indicate changes in its price. The law of demand says: the higher the price, the less they will buy. High elasticity will make the curve almost horizontal. Low - vertical. Consider an example. Imagine that a ten percent increase in gas prices will lead to a 50% drop in demand. The resulting schedule will be more gentle. If the gas station is one in the city. In this case, an increase in the price of gas even by 50% will only lead to a ten percent decrease in consumer willingness to buy it. Coefficient of elasticity demand for goods is less than one (to be precise, 0.2). The resulting chart will be almost vertical.

Elasticity and Total Revenue

We continue to use the example with a gas station. How will the commercial balance of the enterprise change with increasing gas prices? Total revenue is the value times the amount sold. In our example, the price increases by 10%. But will it cause a similar increase in total income? This is affected by the elasticity of demand. If it is more than one, then the total income will decrease. This is due to the fact that a ten percent increase in prices will not cover the fall in sales. However, in the case when the value of the coefficient of elasticity of demand is less than unity, the total income will increase. There is a clear relationship between these two indicators. If the demand is elastic, then the percentage change in the quantity purchased will exceed the difference between the new and old prices. Total revenue will move in the same direction as quantity. If demand is inelastic, the percentage change in the volume of purchased will be less than the price. The total income in this case moves with the latter.

Examples of Inelastic Demand

The presence of a single gas station in the city is a factor that forces car owners to buy gasoline in it even with an overvalued price. We say that the elasticity of demand for a product is low if a price increase causes a slight change in consumed volumes. Such products include:

• Petrol. This product has only a few substitutes. Car owners cannot do without it. You can, of course, do without a car. But for many, a car is a necessity. There are so-called weak substitutes, for example, walking or traveling by bus. But in most cases, if the price of gasoline rises, then demand for it will fall slightly.
• Salt. If the price of this spice rises, then demand will remain virtually unchanged. This is due to the fact that it takes away a very insignificant part of the consumer’s income. In addition, salt is not bought very often. Moreover, it is a commodity that has no substitutes at all.
• Products manufactured by a monopoly producer. Demand for such products is usually inelastic. Although the role is also played by the need to purchase these products.
• Tap water. To date, this service has no alternatives. If the price of tap water rises, then people will have no choice but to get additional banknotes from their wallets. That is why this service is usually controlled by the state.
• Diamonds Luxury goods are a completely different story. Diamonds are a measure of status. Falling prices will not increase demand much.
• Ticket prices for suburban routes.People need to get to work somehow, so the demand for them will be inelastic. All due to the lack of alternatives.
• Cigarettes If the tobacco tax rises, most will continue to smoke anyway. They are addicted to cigarettes, so they will continue to buy them.
• Apple products. Many people are so loyal to this particular brand that they are ready to pay more for “apple” goods, even if there are full substitutes on the market.

Elastic Demand Products

The presence of several gas stations creates competition for the client in the city. Therefore, one of them cannot simply raise the cost of gasoline and count on an increase in its own total income. If the coefficient of elasticity of demand is equal to a number greater than one. Such products include, but are not limited to:

• Seasoning for Mivina soups. Today she has a lot of analogues. Therefore, increasing the price of it will lead to the fact that many consumers simply abandon it.
• Gasoline WOG. We said that the demand for gasoline is inelastic. But increasing the price of a separate gas station will lead to the fact that people will start buying fuel for their car on another. The only exception is the local monopoly. But in a big city, such a situation is not possible.
• Bread "Delis". There are many alternatives on the market. Therefore, in the event of a significant increase in prices for these manufacturers, people will simply begin to buy other brands.
• The newspaper Moskovsky Komsomolets. If the price rises, then people will start reading others. Demand for Cosmopolitan or The Forbes will be less elastic.
• Chocolate bars Aero. There are many imported and domestic analogues on the market. Therefore, the demand for them is elastic.
• Sports cars Porsche. Such a purchase takes a significant part of the consumer’s income, so increasing the price can scare away a large number of buyers. In addition, there are analogues, for example, Jaguar or Aston Martin. Although some fans of the brand will still continue to buy a Porsche.

Income elasticity of demand: examples

We dealt with goods whose purchase volumes are sensitive or not very price-sensitive. Now consider the income elasticity of demand. This indicator is equal to the result of dividing the amount purchased by the changes in consumer wages. The goods with high elasticity of income include:

• Sports cars Porsche. If a person’s income increases, he will be ready to pay more for a new car.
• Organic bread. If the income of consumers becomes larger, then they begin to take care of their health by buying expensive and healthy products.
• Handmade soap. An increase in income will force consumers to turn their attention to more expensive analogues of everyday things. Handmade soap looks and smells better than usual in cardboard packaging.
• Expensive gasoline. If the income of the car owner increases, then he has the opportunity to buy more expensive fuel, which increases the life of the engine.

To goods with low elasticity of income include, for example, fruit. If people's income increases, they can buy more bananas, but many believe that they already eat enough of them. Although this does not apply to the poorest.

Offer metric

Marshall's “scissors” include another curve besides demand. The volume of supply of goods is a value that increases as market prices increase. This is the objective law of this indicator. Supply growth is due to the fact that any manufacturer seeks to get the maximum possible profit. Therefore, an improvement in market conditions will lead to greater utilization of factory facilities. Factors that affect the offer include:

• Availability of substitutes and complementary goods.
• The level of technology development.
• The amount of available resources.
• The amount of government subsidies.
• Tax rate.
• Natural and climatic conditions.
• Socio-political and inflationary expectations.
• The size of the national and international market for this product.

Elastic offer

Everything seems to be in demand here. An elastic supply means that an increase in price causes a larger percentage change in output. This situation is possible when the company can easily increase production. If the car factory uses only 70% of its production capacities, then it can easily increase output with an increase in the price of cars. A completely different option is an inelastic proposal. This means that the percentage of price changes is less than the difference between the new and old output. These products include:

• Potatoes in the short term. If its price rises, then farmers will not be able to provide a larger supply this year. This is due to the fact that it is planted in March, and then nothing can be changed.
• Nuclear fuel. Launching new reactors will require significant time costs, since they need not only to be built, but also to hire and train specialists who will work there.

Distinguish the elasticity of supply at the price and substitution factors. The latter shows how much percent you need to change the ratio of resources so that output remains unchanged.

Supply Elasticity Factors

The determinants that cause a greater or lesser change in output with rising or falling prices:

• Production technology.
• The elasticity of the supply of used resources.
• Expectations of manufacturers regarding future prices.
• Amount of time.

Application concept

Calculating the elasticity of demand for a product is much more than just a school task or an intellectual exercise. From understanding this concept depends on whether the company will be successful or failure. The calculation of elasticity is used in a huge number of areas of the economy. In particular, it is very important for understanding the demand and supply in the market. The most common uses of elasticity are:

• Measuring the effect of a change in the price of a firm’s income.
• Analysis of the tax burden and other state policies.
• Income elasticity of demand is used as an indicator of industry health and future consumer behavior and a factor in making investment decisions.
• Measuring the effect of international trade.
• Analysis of consumer behavior, their habits of accumulation.
• Finding the effect of advertising products on demand for them.

The ease of calculation encourages economists to find even more areas for applying elasticity. Any two values ​​can be compared by this indicator, if their values ​​are known in two periods. In this case, the arbitrary units in which they are expressed are not important. In any case, the elasticity index is calculated on the basis of percentages; therefore, quantitative changes in them can be easily translated.