Definition
Elasticity of Supply: Elasticity of supply measures the responsiveness of the quantity supplied of a good to a change in its price. It is computed as the percentage change in the quantity supplied divided by the percentage change in price. Supply is said to be elastic if the elasticity exceeds 1 and inelastic if it is less than 1. High price elasticity indicates that supply can significantly increase in response to price changes.
Elasticity of Demand: Elasticity of demand measures the responsiveness of the quantity demanded of a good to a change in its price. It is calculated as the percentage change in the quantity demanded divided by the percentage change in price. Demand is considered elastic if the elasticity exceeds 1 and inelastic if it is less than 1. For example, the demand for luxury items may decrease dramatically if prices rise, as these purchases are not essential and can be postponed.
Examples
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Elastic Supply Example: Agricultural products often demonstrate elastic supply. A small increase in the price of wheat might lead to a substantial increase in the quantity supplied, as farmers shift production to capitalize on higher prices.
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Inelastic Supply Example: Real estate development demonstrates inelastic supply. A significant price increase in real estate does not immediately lead to a proportional increase in new houses due to long construction lead times and zoning regulations.
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Elastic Demand Example: Luxury goods like high-end cars often exhibit elastic demand. A small increase in the price can substantially reduce the quantity demanded as consumers may opt for less expensive alternatives.
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Inelastic Demand Example: Essential medications show inelastic demand. Even substantial price increases have little effect on the quantity demanded because these medications are necessary for consumers.
Frequently Asked Questions
What does a price elasticity of 1 mean?
A price elasticity of 1, or unit elastic, indicates that the percentage change in quantity demanded or supplied is exactly equal to the percentage change in price.
How is elasticity different for necessities vs. luxury goods?
Necessities typically have inelastic demand because consumers will continue to purchase them regardless of price changes. Luxury goods have elastic demand as consumers are more sensitive to price changes and can defer purchases.
What factors influence the elasticity of supply?
Factors include production flexibility, time period for production, availability of factors of production, and mobility of factors of production.
Why is elasticity important for businesses?
Understanding elasticity helps businesses set prices, forecast revenue, and develop strategies for supply chain management.
How does income affect elasticity of demand?
Income levels can impact demand elasticity. Higher income consumers may have more elastic demand for luxury items, while lower income consumers may have more inelastic demand for essential goods.
- Cross-Price Elasticity of Demand: Measures the responsiveness of the quantity demanded for one good to a change in the price of another good.
- Income Elasticity of Demand: Measures the responsiveness of the quantity demanded to changes in consumer income.
- Perfect Elasticity: When a small price change causes an infinite change in quantity demanded or supplied.
- Perfect Inelasticity: When price changes have no effect on the quantity demanded or supplied.
Online Resources
Suggested Books for Further Studies
- “Principles of Economics” by N. Gregory Mankiw
- “Microeconomics: Theory and Applications with Calculus” by Jeffrey M. Perloff
- “Intermediate Microeconomics: A Modern Approach” by Hal R. Varian
Fundamentals of Elasticity of Supply and Demand: Economics Basics Quiz
### What is elasticity of supply?
- [x] The responsiveness of output to changes in price.
- [ ] The percentage change in the quantity demanded.
- [ ] The fixed rate at which supply increases.
- [ ] The limit to how much firms can produce.
> **Explanation:** Elasticity of supply measures the responsiveness of the quantity supplied to a change in price, calculated as the percentage change in quantity supplied divided by the percentage change in price.
### When is supply said to be elastic?
- [x] When the elasticity exceeds 1.
- [ ] When the elasticity is less than 1.
- [ ] When price drops and supply decreases.
- [ ] When there is a surplus in the market.
> **Explanation:** Supply is elastic if the elasticity exceeds 1, meaning a small change in price results in a large change in quantity supplied.
### Which factor increases price elasticity of supply?
- [ ] Strict production regulations.
- [x] Availability of factors of production.
- [ ] Longer lead times.
- [ ] Lack of production technology.
> **Explanation:** The availability of factors of production allows firms to respond more quickly to changes in price, thus increasing price elasticity of supply.
### What indicates a perfectly inelastic demand?
- [ ] A small change in price causes a large change in quantity demanded.
- [x] Price changes have no effect on the quantity demanded.
- [ ] The demand curve is horizontal.
- [ ] The price elasticity is greater than 1.
> **Explanation:** Perfectly inelastic demand means that changes in price do not affect the quantity demanded; demand remains constant.
### Which goods typically show inelastic demand?
- [ ] Luxury watches
- [x] Essential medications
- [ ] Designer clothing
- [ ] High-end electronics
> **Explanation:** Essential medications have inelastic demand because they are necessary for health, and consumers will purchase them regardless of price changes.
### How does income elasticity of demand relate to luxury goods?
- [x] Luxury goods have higher income elasticity.
- [ ] Luxury goods have lower income elasticity.
- [ ] There is no connection between income and luxury goods demand.
- [ ] Income elasticity only pertains to essential goods.
> **Explanation:** Luxury goods generally have higher income elasticity, meaning demand for these goods increases more than proportionally as consumer income rises.
### What happens if a product has an elasticity of 0.5?
- [ ] The demand is perfectly elastic.
- [y] The demand is inelastic.
- [ ] The supply is elastic.
- [ ] The supply is perfectly inelastic.
> **Explanation:** An elasticity coefficient less than 1 (0.5) indicates inelastic demand, meaning quantity demanded is less responsive to price changes.
### Which industry most likely has an elastic supply?
- [x] Agriculture
- [ ] Real estate
- [ ] Automobile manufacturing
- [ ] Heavy machinery
> **Explanation:** Agriculture often has elastic supply because farmers can adjust production levels relatively quickly in response to price changes.
### What does a higher price elasticity of demand signify?
- [ ] Consumers are less responsive to price changes.
- [x] Consumers are more responsive to price changes.
- [ ] There is no change in demand regardless of price.
- [ ] Only luxury goods are affected.
> **Explanation:** A higher price elasticity of demand indicates that consumers are more responsive to price changes, meaning they are likely to reduce consumption significantly if prices rise.
### Why might a business analyze the elasticity of supply and demand?
- [x] To set optimal pricing strategies.
- [ ] To determine the color of product packaging.
- [ ] To know the legal regulations in place.
- [ ] To forecast the weather.
> **Explanation:** Analyzing the elasticity of supply and demand helps businesses set pricing strategies that maximize revenue and profitability by understanding how quantity supplied and demanded respond to price changes.
