The Concept Of Elasticity In Economics

The definition of price elasticity of supply (PES) means that the measurement of the changes in quantity supplied to a change in the price. There are few determinants of price elasticity of supply. One of the determinants is the ability of the suppliers to change the output. If the easier the supplier to change their outputs, then the more elastic the supply of a product will be. For example, producer A able to produce many product for his company then the percentage of the changes in price is lower, so the supply will be elastic. The other determinant is the time to respond. In the time to respond, there is the long run, short run and the market period. Most of the supply is more elastic to the long run rather than the short run to the goods produced. Almost all factors of production can be used to increase the supply. While in the short run, it can only increase the labor. For example, a wheat farmer cannot instantly react to an increase in the price of corn because of the time will take to procure the needed land.

Part B

The concept of elasticity in economics is that to measure the receptiveness of quantity demanded or quantity supplied to change the determinants. The type of elasticity is price elasticity of demand, price elasticity of supply, income elasticity of demand and also cross elasticity of demand. There are many way of businesses use the concept price elasticity to decide on their pricing strategy. A business will mostly see the demand of the consumer before they start to price their product. If they put the price high, the demand will be lower. But somehow, if the producer put a lower price to a product, the customer will also not buy it because customer assume that the cheapest things does not have the quality. So, a company should be smart to price their product and have the right pricing strategy. A company business will use elastic demand if product is old and the company is having a stock clearance because elastic demand will decrease the price but the quantity demanded will increase. As for the income inelastic, it is a rise of quantity demanded smaller than the income for the company to sell the normal good. Income elastic is the rise of quantity demanded larger than the income for the luxury good. Income elastic is a very good pricing strategy for a company because many consumers are willing and able to buy the product at a high price for their own satisfactory. A business company uses the price elasticity of supply to measure the changes in quantity supplied of a product to a change in price of the same product. Price elasticity of supply is normally positive value and it is suitable for a company for their pricing strategy. There is also the cross elasticity of demand to help the business decide their pricing strategy. Cross elasticity of demand means that the change in quantity demanded of a product to a given percentage change in the price of the other product. By using the cross elasticity of demand, a company can know a product is a substitutes, complements or unrelated. This can helps a company to decide the pricing on their product. A company business will use all these concept of price elasticity to decide on their pricing strategy because it can see the overview and also cut down time taken for them to get the report. In conclusion, the concept price elasticity is very important for a company to decide on their pricing strategy.

Question 3

Part A

The definition of supply means that the product of the producers is willing and able to sell. The law of supply gives the meaning that when the price of the product increases, then the quantity supplied will also increases. There are many reasons why supply of a product increases. One of the reason is that the improvement of technology. The improvement of technology allows firms to produce units of output with lesser resources. This is because the resources are very expensive for the production. For example, if a firm in an industry uses better production techniques, the industry supply curve will shift to the right and this will cause the increase product of supply. Besides that, the reason is the producer expectation. Producer will make his/her own expectation about the future price of a product so that the producer can make a decision to buy the product now or later. For example, if a manufacturing industry made a new expectation on the increase of price, the industry will quickly increase more workers and also increase their production facilities and this will cause the supply to increase. Taxes and subsidies is also the reason why the supply of a product will increase. Taxes mean that the amount of money charge to the producer for the production cost. Meanwhile, subsidies are the opposite meaning of the taxes. If the government decrease the tax or increase the subsidy of production, the supply of a product will increase. For example, the government subsidizes the production of good this week, than it will reduce the producers’ cost to make their production and it will increase the supply of product.

Part B

Price ceiling or maximum price is a line set below of the equilibrium price. This line is set by the government for the producer to set their own product price. Price ceiling is a maximum legal price for the producer to price their product. If the price is lower, it will attract the customers, but hinder suppliers. It will cost shortage is the quantity demanded increase while the quantity supplied decrease. The governments have to introduce rationing to avoid an unfair allocation of the product. If the price is above the legal limit, it will be called black market and it is illegal. Price floor or minimum price is a line set on top of the equilibrium price. This line is set by the government for the producer to set their own product price. Price floor is a minimum legal price for the producer to price their product. If the quantity supplies exceed the quantity demanded, it will be called surplus of the product. If there is surplus happen, the production of good will be overload and the product can only be sold in minimum price. The producer will sell off their product in a lower price to clear or get rid the product. There is a law for a company to put a lowest wage to pay an employee. If a company set a higher wage than the market price, there will be unemployment appear. Therefore, a minimum wage for the labor will give the people to enter the labor market.

Question 5

Part A

The definition of change in demand means that the demand curve will shift either rightward if the demand increases or leftward if the demand decreases. A change in any one or more of the determinants of demand, besides than the price of the good itself will change the demand curve. For example of substitute goods, a decrease in price of pepsi will decrease the demand for coke. Thus, the quantity demanded for pepsi will increase, interpreted as a movement downward along the same curve. Demand for coke will shift leftward because of the decreases of the demand.

Figure 1

The other determinants is complements, income, tastes and fashion, expectations, weather condition, availability of credit facilities, size of the population and advertisement. Complement goods means that the goods are used together. The example of complement goods are, car and petrol, cell phone and SIM card, fork and spoon and many more. Besides that, the income shows the changes affect demand is more compound matter. Most of the product, the rise of income will cause the increase of demand. The rise of income will also depend on the type of good such as it is either normal or inferior good.

The definition of change in quantity demand means that a movement of upward (increase) or downward (decrease) along the demand curve happens when there is change in quantity demanded. The only factor that changes the quantity demand curve is the change in the price of the goods itself. For example, a movement downward along the demand curve happens from A to B when the quantity demand of the apple increases due to a fall in price of the apple from RM3.00 to RM2.00.

Figure 2

Part B

The definition of income elasticity of demand (YED) means that the percentage change in quantity demanded of a good is divided by the percentage change in income.

There are three types of degrees of YED. The first income elasticity of demand is when the YED is positive, then the income elasticity is greater than 0 (YED > 0). When the demands rise, the income will also rise. There are two category of positive YED. One is the income inelastic (0<YED<1) and the other one is the income elastic (YED>1). The income inelastic means that when the quantity demanded increase by a smaller percentage than the increase in income and it will be assume to be a normal good such as food and clothes. As for the income elastic, it means that when the increase of quantity demanded is bigger percentage than the increase in income, it will be assume to be luxury goods such as branded bags, branded shoes, luxury cars and many more. The second income elasticity of demand is when the YED is negative (YED<0). The income will increase if the demand of goods falls. These goods will be called inferior goods as they give negative income elasticity of demand. The examples are second-hand bags, low quality goods and many more. The last income elasticity of demand is when the YED is exactly zero (YED=0). The quantity demanded will remain unchanged as the income changes either increases or decreases and this good will be called necessity. The examples are shirt, rice, sugar and many more.

Question 6

Part A

The concept of consumer surplus means that a consumer is willing and able to buy at a higher price compare to the original price. This is because the consumer wants that good for his/her own satisfaction although he/her know that the price is way higher than the actual ones. To calculate the consumer surplus, you have to take the maximum price of a consumer willing to pay minus the actual price or equilibrium price. For example, based on the figure 3 assume that C is the actual price which is RM5 and consumer A is willing to pay the amount of a which is RM 10. The consumer surplus is (RM10 – RM5 = RM5). The consumer had pay RM5 extra for the good because of his satisfaction to buy that good. Based on the figure 3, inside the triangle APC is the consumer surplus. The examples of good which makes consumer surplus are such as cigarette, cooking oil, vehicle petrol and many more.

Figure 3

The concept of producer surplus means that producer receive a benefit surplus in markets. It also means that a producer is willing to receive a minimum amount of acceptable price. It shows that the producer agree to sell his product in a low price to a consumer because most of the producer are willing to sell the product lower than the actual price. Based on figure 3, the area of triangle PBC is the producer surplus.

Part B

Production possibilities frontier (PPF) is a graph that display the different combinations of two outputs. The PPF can be a linear and also a convex line graph. There are three economic concepts using the production possibilities frontier which is scarcity, choice and also opportunity costs. Scarcity means that in a situation when there is lack of resources to produce as many goods as the people wanted or it is called unlimited wants. There are four categorize resources which are land, labor, capital and entrepreneurial ability. Land is the natural resource, labor is the physical and mental talents of individuals, capital is the owner’s investment and entrepreneurial ability is the extraordinary ability. Because of the scarcity, society has to make the decision to choose between the productions of two goods with the scarce resources prepared. As for choice, people are forced to make a choice and forgo to fulfill their wants. The individual has to choose one item and forgo another item while it will evaluate the individuals’ marginal benefits and marginal costs to make the individuals’ satisfaction. Opportunity costs means that the action taken to choose a item and the another one must be sacrifice. The sacrificed item is called opportunity costs. Almost all the choice will involves with opportunity costs.

Combinations

Foods

Toys

A

10

B

5

5

C

10

Table 1

Based on table 1, it shows that an individual have to choose between this there combinations A, B or C. If the individual choose combinations A, he/she have to forgo foods and the food will be scarcity for that individual. It is same as combination C but the item forgo is toys. As for combination B, the individual will have both foods and toys equally. The individual have his/her own choice to choose. The opportunity cost will happen if the individual choose any combinations above.

Referencing

Wikipedia2001-2010, online, retrieved on 15 April 2010.

From: http://en.wikipedia.org/wiki/Price_elasticity_of_supply#Determinants

Economics, 2008, Principles, Problems, and Policies, 17th edition, McGraw-Hill.

Microeconomics, 2004, A contemporary introduction, 2nd edition, Nelson Australia Pty Limited