Determinants Of Price Elasticity Of Supply
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Published: Tue, 21 Jun 2016
The two determinants of price elasticity of supply are production time period and the availability of factors of production.
Production Time Period
In short term, due to deficient availability of time to organize and adjusts the supply to demand, so supply is more tends to inelastic.
In long term, supply is more elastic. Sellers are more responsive to change the price since they can adjust their supply. Example is manufactured products.
For primary goods, it is remaining the longest inelastic, because primary goods are hard to expand and increase its production speedily. It is take a long and many times to plant, cultivate and harvest.
Nature of the Market
Supply is more tend to elastic when a product can be selling in another market. This is because when the price of goods is falls in one market, it does not will fall in other market, and will made good.
The businesses need to know the reaction of the consumers towards a price changes. So means that, the information that collected on price elasticity of demand is very useful to the businesses to decide their pricing strategy since it will affect his total revenue. Total revenue can be defined as price multiplied with quantity.
Total Revenue=Price x Quantity Demanded
When consumers react strongly to an increase in prices, the total revenue will move in the opposite direction of the price changes and vice versa.
If the demand is more tends to inelastic, the businesses can increase their price to lead the increase in their total revenue and decrease in price will lead to a decrease in total revenue. The price and total revenue in demand inelastic will move in same direction and will not the opposite direction. For example, the price of petrol is RM 2.00 per litre, and the total revenue of 20 litres is RM40.00. So, when the price increases to RM 2.50 per litre, the quantity demanded of petrol will fall to 18 litres. At last, the total revenue will increase from RM 40.00 to RM 45.00. The result of total revenue is shown the businesses of petrol had been increase RM 5.00. So means that an increase in price will lead to an increase in total revenue since the quantity demanded is less sensitive to the price changes.
If the demand more tends to elastic, an increase in the price will make to a decrease in total revenue and decrease in the price will make to increase in total revenue. The price and the total revenue will be always on opposite direction. For example, if the price for clothes is RM16 per unit, the total revenue that earns from 30 units clothes is RM480.00. If there have an increase the price for one unit clothes, from RM16 to RM20, this will lead the fall of 10 units clothes in quantity demanded and the total revenue at last will be RM200. Elastic demand is more sensitive in change in price of a product.
If the demand more tends to unitary elastic, the changes of the price no matter is increase or decrease, it definitely will not affected the total revenue. The total revenue will not be changed in unitary elastic this is because the percentage change in price is equal to the percentage change in quantity demanded.
In conclusion, if the demand is more tends to inelastic, the businesses can increase their price to lead the increase in their total revenue and decrease in price will lead to a decrease in total revenue. On the other hand,if the demand more tends to elastic, an increase in the price will make to a decrease in total revenue and decrease in the price will make to increase in total revenue.But, if the demand more tends to unitary elastic, the changes of the price no matter is increase or decrease, it definitely will not affected the total revenue.
The three reasons why supply of a product increases are resource prices, technology, and number of sellers in the market.
These three reasons are the main factor to make the shift in the supply of a product either it is shift to left or right.
The higher resource prices normally will increase or raising the production costs and this will make the output of a firm decreasing and reduce the profit and supply of the firm. For an example, increases in the salary of the labour and the price of capital equipment in the production of furniture, it will increase the costs of production and then reduce the supply and decrease the profit that earn by firm.
The improvement of technology enables producers to use the fewer resources to lower the cost of production and increase the supply. For an example, advance technology in paddy harvest will make the harvest easier, save time, save cost and this will increase the supply of rice.
Number of Sellers in the Market
A market greater or not is depend on the number of sellers. If the sellers in a market are larger, then the market will be greater. Increase in the number of sellers means that there have many firms are entry into the market, and the market do not have shortage in supply and the quantity supplied in the market will be larger. For example, if the number of the food corner in the shopping mall increase, the supply of food and drink will be increase.
The price mechanism noticeable the market forces to controls the allocation of economic resources and distribution of goods and services. The basis prices for rationing of resources and the quantities of goods desired is readjust prices in the market.
The role of governments in the market cannot be ignoring, because the price will control by governments. In the market place, the action of distorts realistic can induce semi-permanent shortages and surplus. The maximum price is the price ceiling and the price ceiling is for consumer. The maximum price must be below the equilibrium price, it means that the quantity demanded increase when the quantity supplied decrease. It would lead to shortages.The price ceilings do not necessarily hold the price down but they can increase them. The price ceilings are upper limits to price and with consumer protection.
$ / Price
0 Quantity demanded
Q3 Q1 Q2
The price floors are the minimum prices that produces can receive for their products. It means that the quantity demanded decrease and the quantity supplied increase. The price floors are to protect producers and to ensure a price for their daily necessities that is above the equilibrium values and those huge surpluses more easily to accumulate. In the market place, more inferior goods will be produced and can be sold at minimum price.
$ / Price
0 Q2 Q1 Q3 Quantity demanded
A change in one and two or more of the determinants of demand will cause a change in demand. A decrease in demand it is shown a shift of the demand curve will shift to the left. A change in tastes an important role in demand curve shifts. An unfavorable change in consumer tastes and preferences will decrease in demand, the shift of demand curve to the left. For example, a vegetarian consume do not eat the meat, so the demand for all type of meat will decrease and the shift of demand curve to the left.
However, a change in the price of a related good may either increase or decrease the demand for a product. The related good is depending on whether of substitute good or complementary goods.
A pair of goods which are considered by consumers to be alternatives to each other is considered as substitute goods. As the price of one good increasing, the demand for the other good will increase. If the lower the price of substitute goods, the lower will be the demand for this good as people switch from the substitute. For example, when the price of Chocolate ice-cream decline, consumers will buy more of it and decrease their demand for Vanilla ice-cream.
Pair of goods consumed together is called complementary goods. As the price of one good increase, the demand for both goods will decrease. If the higher the price of complementary goods, the fewer of them will be bought, hence the less will be the demand for this good. For instance, if the price of Computer increases, the demand for computer will fall and demand for diskette will also decrease as both used.
Price of orange per kg ($/kg)
$ 10 â—A
$ 5 â—B
0 10 20 Quantity demanded of orange (kg)
Decrease in quantity demanded is happen when a price of a goods changes and there is upward movement along demand curve. For example, a movement upward along the demand curve from point B to point A shows a decrease in quantity demanded from 20 units to 10 units for orange due to a rise in price of orange from $5.00 to $10.00. The following graph shown the example for decrease in quantity demanded.
The definition for income elasticity of demand indicates the responsiveness of demand to a change in consumer incomes. The formula for the income elasticity of demand (YED) is percentage change in quantity demanded divided the percentage change in income.
% âˆ† in quantity demanded
% âˆ† in household income
If the income elasticity of demand (YED) is exactly zero (YED=0), the quantity demanded for product does not change even though income increase. The degree of zero income elasticity of demand is a necessity good. For example, rice, salt and so on.
If the income elasticity of demand (YED) is less than 0 (YED<0) the income elasticity of demand is negative, the quantity demanded decrease as the income increase. The degree of negative income elasticity of demand is an inferior good. For example, when consumer income increase it will directly decrease for the quantity demanded for used car, salted fish and the low grade potato.
If the income elasticity of demand (YED) is greater than 0 (YED>0), it will cause the demand to increase as the income increases.
The positive an income elastic of demand is greater than 1 (YED>1), the quantity demanded rise as an income rise. The degree of positive income elastic of demand is a luxury good. For examples:gold, jewelry, antique furniture and luxury car such as BMW, Mercedes and others.
Price (per pack)
P1 â— Equilibrium price = $5
0 Q1Quantity demanded of packs
The consumer surplus can be defined as difference between the maximum amount consumers are willing to pay for a product and the actual amount. For an example, if the buyer is willing to pay $15 for an apple per pack and the buyer bought it for $10 and the $5 difference is counted as the consumer surplus.
Price (per unit)
Producer surplus S
P1 â— Equilibrium price = $3
0 Q1 Quantity demanded of scissors
The producer surplus can be defined as difference between the actual amount a seller receives and the minimum receivable amount. For an example, if the actual price for scissors is $5 and the seller sell it for $8. The $3 is the producer surplus.
Three concepts of economic are scarcity, choice and opportunity cost. The scarcity can be defined as wants always exceed limited resources to satisfy clients or society. However, the choice also can be defined as when there is scarcity, choices have to be made. The last the definition of opportunity cost is the amount of other products that must be forgone or scarified to produce a unit of a product. For example, the producer sells the computer and the television at the digital mall. The consumer has to make a choice between the computer and the television. If the consumer chooses the computer, the television is the opportunity cost by that consumer.
130 â— A
100 â— B
80 â— E â— C
50 â— D
0 computer good
70 110 130 200
In the production possibilities graph, the horizontal axis show the quantity of computer produced by the economy and the vertical axis shows the quantity of television produced.
For example, at the point A the economy that can produce 130 television and 80 of computer. On the other hand, at the point E, the economy can produce 80 television and 70 of computer. The frontier between the shaded and unshaped area is called production possibilities frontier, because it separated the combinations that are attainable from those that are not.
The attainable combinations are shown by the shaded area within the frontier and the frontier itself. The unattainable combinations are shown by the unshaped area outside the frontier. The points on the frontier show the combinations that are possible if economy’s resources are fully employed.
Sloman, J 2006, Economics, 6th Edition, Pearson Education Limited, Harlow.
Mankiw, G 2007, Principles of Microeconomics, 4th Edition, Thomson South-Western, Mason.
O’Sullivan, A ,Sheffrin, S and Perez, S 2008, Economics: Principles, Applications, and Tools, 5th Edition, Pearson Education, New Jersey.
Mitchelson, P & Mann, A 1995, Economics for Business, Thomas Nelson Australia, South Melbourne.
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