Elasticity is a measure of the sensitivity of supply and demand to changes in factors that define them, primarily to a change in the value of the goods. (Mankiw, 2009)
In quantitative terms, the elasticity means the degree or measure the response in one variable to the result of a one percent change in another variable value. The most important role in the elasticity of supply and demand plays a varying demand that depends on the prices.
The main factors influencing price elasticity of demand are:
Availability of high-quality interchangeable goods and the price level on them (the more substitutes and the lower the prices are, the more elastic the demand);
The proportion of product income of the consumer (the important place occupies a certain product in the budget of the consumer, the higher the elasticity of demand at constant all other terms and conditions);
The duration of the period for the exercise of choice (the longer the period of time for making decisions, the more elastic the demand for the product);
The type of goods, in particular their division into luxury goods and consumer goods (demand for luxury goods mainly elastic, on commodities is inelastic).
The elasticity in the case of price changes shows the change in the demand rate is a price reduction, for example, 1 %. This dependence is expressed by the formula:
En = (%DK) * (%DP),where K is the quantity of demand; P — price; %DK % change; %DP is the percentage change in P. (Mankiw, 2009)
If the index of prices of consumer goods amounted to 100 at the beginning of the year, and at the end of the year rose to 105, then the percentage change or annual rate of change of inflation will be (5:100) = 0,05 or 5%. Therefore, the demand elasticity depending on price changes will be as follows:
Ep = (DK / K) / (DP / P) = (P / K) * (DK / DP) ,
that equals the change in quantity due to a unit change (DK / DP) multiplied by the ratio of price to quantity (P / K). (Mankiw, 2009)
A simple formula of elasticity, more precisely, the price elasticity is as follows:
Ep = (percentage change in the quantity of goods, which have demand) / (percentage change). (Mankiw, 2009)
The percentage change is determined by dividing the change in the price of the original price and the corresponding changes in the quantity of goods for which the percentage change causes a decrease in demand for the number of products which were initially the demand. Therefore, this formula can be written as:
Ep = (percentage change in the quantity of goods demanded / percentage change in price) / (change of price / original price). (Mankiw, 2009)
Elasticity of demand depending on the growth rates is mainly negative. This means that with rising prices the demand for goods decreases.
There are also cross-elasticity of demand, which in the case of significant changes in the price of a single product demonstrates the trend in consumer demand from one product to another. This coefficient of elasticity shows the extent to which changes in the demand for one commodity in interest depending on the changes of the other goods by 1%.
The main features of the elasticity of demand for a product is the growth elasticity to it with the growth of its substitutes and the approach of their quality (total consumer costs), or increased possibilities of its use. At the same time reducing the elasticity of demand for goods comes with the increased importance of the needs that meets this item, limited access to it, the duration of the period of existence of the product and so on.
Similarly, the measured elasticity of supply — dependent prices percentage change in quantities of items due to a one percent growth rate. Mostly this value of elasticity is positive because a higher price is an incentive for producers to increase the production of goods. A special feature of the market mechanism is that the demand is more elastic than the price for a long, not a short period of time. This is because people don't immediately change their habits in the consumption of goods, as well as the fact that the demand for one commodity may be connected with a supply of another product at consumers, which varies more slowly. Thus, the sharp increase in gasoline prices, though, and reduces the demand for it, but to a lesser extent. At the same time for a long period of time consumers will try to buy small-displacement and fuel-efficient vehicles. Typically, in a competitive consumer market the unit price of a particular product goes on changing until settling at a specific point where the quantity demanded by the end users equals the quantity supplied to the market, resulting in an economic equilibrium (Varian, 2010).
The most important factors influencing the elasticity of supply (except price) are the number of producers, expectations (price and others) of economic agents, the value set by the state taxes, the time factor and the like.
The relationship between elasticity of supply and demand reveals the law of supply and demand. Its content lies in the interdependence between the amount of goods and services offered by the manufacturer, and the magnitude of demand. This law does not contain the shortcomings of the two previous laws.
The law of supply and demand is the law, according to which the supply creates demand through the assortment of produced goods and offered services and their prices, and the demand determines the volume and structure of supply, affecting production. (McEachern, 2009)
The price elasticities of demand and supply show how responsive buyers and sellers are to changes in the price of a good. Depending on the magnitude of the coefficient of elasticity there are such main types of elasticity of supply and demand:
supply and demand are absolutely elastic;
supply and demand are relatively elastic;
supply and demand are relatively inelastic;
supply and demand are absolutely inelastic. (McEachern, 2009)
Absolutely elastic demand is characterized by the fact that the slightest reduction in prices induces the buyer to increase purchases from zero to the limit of their capabilities. Relatively elastic (or elastic) is the demand when small changes in price cause a large (large) changes in the number of sales (for example, reduction of price of 2% causes an increase in demand of 4%). The coefficient of elasticity for this elasticity must be greater than one, and in this example it is equal to two. So, in particular, is the demand for luxury goods. Relatively inelastic demand — the demand when a small change causes an even smaller change in the number of sales. So, with reduced prices by 3%, demand is growing only 1%. The elasticity coefficient in this case is 1/3, that is, for inelastic demand characteristic coefficient less than unity. Thus, for example, is the demand for bread. Among these types of elasticity of demand (elastic and inelastic) is an intermediate situation — a unit elastic demand — when the percentage change in price equals the percentage change in demand (for example, when a price reduction of 1% causes an increase of demand by 1%). Completely inelastic demand is the demand when the price change causes no change in the number of sold products (in particular, the demand for salt).
For inelastic demand producers to profitably raise the price of the product, as it causes the growth of its profits. Under conditions of elastic demand the producer is profitable to reduce prices, because it causes the growth of income. Knowledge of the degree of elasticity of demand allows businesses to predict customer behavior and their operations.
References
Mankiw, N. (2009). Principles of economics (5th ed.). Fort Worth, TX: Dryden Press.
McEachern, W. (2009). Economics. Mason, OH: South-Western Cengage Learning.
Varian, H. R. (2010). Microeconomic analysis. Mumbai: Viva Books.
