Determinants Of The Price Elasticity Of Supply Economics Essay
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Published: Mon, 5 Dec 2016
The price elasticity of supply is the measurement of the responsiveness of producers on the changes in the price. The determinants of price elasticity of supply include time period and the existence of spare capacity.
The first determinant is time period. Producers usually cannot provide more supply of their product in a short period of time immediately. The longer the time period, the more product will be supplied. For example, an industry which produces 5000 bottles of milk per month. If the demand increases suddenly, government suggests to produce 10000 bottles of milk per month. The industry is not able to change their productivity in a short time of period. Perhaps after few weeks, they are only able to produce the quantity which is needed by the market.
For long run, the suppliers will be able to find an alternative way to obtain enough resources or raw materials used to produce the goods. Thus, more goods will be produce easily. The supply therefore is vey elastic.
However, short run means that the producers need to supply more in a short period of time to achieve the quantity demand of the market. In this case, suppliers are very difficult to supply more because they do not have enough time to prepare for it. Hence, the supply will become very inelastic as need to supply more in a short time of period.
The second determinant is existence of spare capacity. If the capacity of a firm of industry is larger, more stock can be kept inside. At the same time, suppliers are able to supply more. In this condition, the supply will become more elastic. As a restatement, the larger the capacity, the more elastic the supply is.
For an example, Mr Leong has started a business on selling cell phones. Its elasticity coefficient is estimated as +10. The business plans to increase its annual quantity of cell phones by 10%. The price of the products has to drop in order to increase the quantity to be sold. Price elasticity of demand concept will be used to calculate the percentage decrease in price of the cell phones:
( percentage change in quantity demand ) / ( percentage change in price )
= elasticity of demand
= 10 / X = +10
X = 1
As a conclusion, the price needs to decrease by 1% to increase the quantity to be sold by 10%.
Businesses use price elasticity to determine their pricing strategy. If the demand for a good is elastic, producers will try to lower down the price in order to maximise the total revenue in a business. For instance, the demand for nike shoes is elastic. Therefore, producers will lower the price of nike shoes to raise the total revenue at the end. That is why mega sales are organised annually every where to earn additional profit.
However, if an inelastic product has been produced by a producer, he or she will try to raise the price to cover his or her loss. This is because the responsiveness of the consumers is very little if the product is inelastic, although the price has dropped. For example, swatch watches are inelastic products. Producers will increase the price to get more revenue, instead of decreasing the price of product to increase the quantity to be sold.
Supply of a product will increase as the determinants of supply changed. One of the determinants is cost of production. Cost of production is amount of money or assets used to produced a good. When it decreases, the supply of the good will increase. This is because producers are willing to produce more as the cost of production is lower.
For example, Mr Wong is a vase producer. He usually produces 30 vases per month. Unfortunately, the price of raw material which is used to produce vases has decreased. At the same time, cost of production increases. Hence, Mr Wong, as a producer willing to produce more under lower cost of production, but to earn more profit than before.
Besides that, the improvement of technology can cause the supply of a product increases. Nowadays, technology is improving and able to invent machine or use lesser time and resources to increase the productivity of a product. Thus, a large amount of product can be produced during a short period of time, so the supply will increase.
For illustration, nowadays technology enable to raise the productivity of vehicles as machines are invented. Therefore, lesser time is used during the producing process. However, more products have been produced. Supply of a product is therefore increased.
Finally, the expectation of producer will cause the supply of a product to increase. When a producer expect the price of a product will increase in the future, the producer will take the opportunity to increase the supply of the product in order to earn more profit when the expected price actually increased.
For instance, the price of salt is expected to raise in the future. Producers will produce more now in order to get additional profit in the future. Hence, supply of a product increases.
Rationing function of price is the capability of the competitive forces of supply and demand to a price at which selling and buying decisions are constant. It occurs to ensure that no surplus or shortage appeared in market. While resource allocation is how the resources are fully used while producing a product to maximise the profit but minimise the cost of production at the same time.
Price floors is the minimum price above the equilibrium price which set by the government. The objective of setting price floors by the government is to protect only the producer but also the consumer. Producers will receive the minimum income while the poor or average consumers is affordable to buy the product. However, if the price floors is too low, shortage will happen at that particular of time. Houses is one of the good examples. If the price floors set by the government is too low, many consumers tend to buy more but the producers are not willing to produce more because the price is low. In this situation, quantity demand exceeds quantity supply, therefore shortage occurred. Moreover, producers will allocate more resources on other more valuable product instead of building a house. Hence, the resources are not allocating in a balance and proper way. Finally, it causes inefficiency in resources allocation. Perhaps some resources will be wasted.
On the other hand, price ceilings is the maximum price which set by the government. It appeared to protect the consumers and also prevent the producers from selling a product at a very high price to achieve a higher profit. In this case, producers only can sell their products below or at the price ceilings. Average and poor consumers will afford to consume a high quality product but under a lower price at the same time. However, if the price ceilings set by the government is too high, a situation called surplus will occur. On the economic point of view, producers are willing to produce more as the price is high. But less consumers are willing to buy the product because of the same reason again. For example, imported vehicles are too expensive for the average consumers. But producers tend to produce more as the price is higher than local vehicles. Many citizens are not affordable to buy imported vehicles. Quantity supply exceeds quantity demand. Shortage is therefore occurred. It is also an imbalance in resources allocation if shortage occurred. Resources used to produce an imported vehicle is more than the resources used to produce local vehicles. Lesser resources are used to produce other goods. Inefficiency in resources allocation occurred.
As a conclusion, government have to find a way to set the price of a product, not too high but not too low also in order to protect both sides which are consumers and producers.
Decrease in demand is a shift of leftward on the demand curve while decrease in quantity demand is an upward movement along the demand curve. Decrease in demand caused by the changes of determinants. While the determinants changed, they will affect the shift of demand curve. The determinants which can cause decrease in demand include taste, income, number of consumers, consumers’ expectation and others.
For example, taste of consumers has changed suddenly. They do not like apple but prefer orange. Therefore, the demand of orange will decrease. A leftward shift will occurred on the demand curve. Others determinants remain constant.
Furthermore, income of consumer also counted as a determinant. When income of consumers decreases, the demand of a product also will decrease. For illustration, Mr Hong’s salary has been deducted into RM1500 per month. He usually buys 10 oranges weekly. However, he has decided to buy 5 every week. The demand of orange decrease and shift the demand curve to the left on the demand curve. Others determinants remain constant.
Besides that, consumers’ expectations will cause changes on demand curve. For instance, consumers expect the price of car will fall by 10%, the demand for car will decrease. Hence, a leftward shift will be seen on the demand curve. Others determinants remain constant.
On the other hand, the only determinant which can cause the quantity of demand to decrease is price of the good. When price increases, the quantity demand will decrease. The higher the price, the lesser the quantity demand. Consumers are not willing to buy a product when the price is not reasonable. Therefore, quantity demand decreases, a upward movement will occur on the demand curve.
Examples or tow different demand curve are as below:
A leftward shift from D0 to D1 on the demand curve. ( decrease in demand )
A upward movement along the demand from point A to point B. ( decrease in quantity demand )
Income elasticity of demand is the measurement of responsiveness to a change in incomes by buying more or less at a particular good. The formula for calculating income elasticity of demand ( YED ) is as below :
YED= the percentage change in quantity demanded / the percentage change in household’s income
Three degrees of income elasticity of demand include negative, positive and zero. A positive value shown in income elasticity of income means that the relationship between quantity demand of a good and income is positive. When income increases, the quantity demand of the good also will increase. Moreover, it can further categorised into tow types:
If the value of income elasticity of demand is from 0 to 1, it means that percentage change in quantity demanded of a good is smaller than the percentage change in income. In this situation, when income increases, quantity demand of a good only increase by a small amount. Examples of the good include food, toothbrush, bus ticket and others. It does not mean that consumers will buy more when their income increases. Those goods are called normal goods.
However, when the value of income elasticity of demand is larger than 1, it means that percentage change in quantity demanded of a good is greater than the percentage change in income. In this case, an obvious increase in quantity demand of a good can be seen easily when income increases. For instance, branded cloths, branded shoes, branded computers and so on. It means that great responsiveness can be seen on quantity demand when income increases but only a small amount. Those goods are called luxury goods.
When the value of income elasticity of demand is smaller than 1 which means negative, the quantity demand falls as the income increases. When consumers’ incomes increase, they are able to buy higher quality, trusted product instead of low quality product such as second-hand cell phone, brandless tissue and others. Those goods are called inferior goods.
When the value of income elasticity of demand is zero, the quantity demand will remain unchanged as the income changed. Consumers will not consume more for a product although their income has changed. For illustration, rice, salt, sugar and more. It does not mean that consumers will buy more when their incomes increase. Those goods are called necessity.
Price of fish ( per kg ) RMConsumer surplus is the benefits received by consumers. The benefit is the difference between the price for consumers willing to pay for a product and the actual price of the product.
Quantity demand of fish (units)
The graph of consumer surplus has been shown as above. This situation happens when the price for consumers willing to pay is higher than the equilibrium price. The point E1 represents equilibrium price. While the shaded area, B1 is the consumers surplus. The graph shows that consumers are willing to pay higher than the price, P1 ( equilibrium price ) for a product. The equilibrium price is now lower than the price which consumers willing to pay. Hence, consumers gained consumer surplus by paying less but also get the same product. For example, consumers are only willing to pay for a fish ( per kg ) is RM5. However, the equilibrium price which both consumers and producers have agreed with is RM3. Therefore, the consumers can save RM2 for buying the same good.
Price of slippers ( per pair ) RMOn the other hand, producer surplus also will occur in the market. Consumer surplus is the benefits received by consumers. The benefit is the difference between the price for producers willing to sell and the actual price of the product.
Quantity demand of fish (units)
For example, Mr Chan expected to earn RM5 for his product, slippers. But the market price is higher than his expected price, which is RM20. Therefore, he earned producer surplus by RM15.
Books ( units )
Computers ( units )
( Graph of production possibility frontier ( PPF ) )
The PPF graph shown the two products, books and computers are produced with the factors of resource and technology fixed.
Scarcity is a situation when there is limited resources but there is unlimited wants at the same time. The point outside the curve consider as unattainable. For example, consumers need 10 books and 10 computers at the same time. The reason is there is limited resources to produce both products needed by the consumers. The resources is insufficient.
Therefore, scarcity always forces the consumers to make choices to maximise their satisfactions. For example, consumers will need to sacrifice 2 books in order to get 2 more computers from point A to point C. It is either to give up good A to gain more for good B, or vice versa. Choices are made depends on the preference of the consumers.
Moreover, the third economic concept is opportunity cost. It is counted as the second best option and it will be sacrificed to gain the best option. When consumers have to sacrifice to get more of another good, the sacrificed good is consider as opportunity cost. For illustration, if the consumers request for 6 computers instead of 4, they have to sacrifice 1 book to get 2 more computers. The book which has been sacrifice is opportunity cost.
Finally, from economic point of view, scarcity forced the consumers to make choices to maximise their satisfaction. The sacrificed choices are called opportunity cost.
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