Price elasticity of supply (PES) Flashcards
PES
Measures the responsiveness of supply to changes in price
PES Calculation
% change in Q.S ÷ % change in P
Interpreting PES results
- PES between 0 and 1
> Inelastic supply - PES = 1
> Unitary supply - PES between 1 and infinity
> Elastic supply
Factors that determine PES
- Spare production capacity*
- Stocks of finished products and components*
- The ease and cost of factor substitution/ mobility*
- Time period and production speed*
*Spare production capacity
- If there’s a lot of spare capacity than a business can increase output without a rise in costs and supply will be elastic in response to change in demand
- The supply of goods and services is most elastic during a recession, when there is plenty of spare labour and capital resources
*Stocks of finished products and components
- If stock of raw materials and finished products are at a high level then a firm is able to respond to a change in price - supply will be elastic
*The ease and cost of factor substitution/ mobility
- If both capital and labour are occupationally mobile then the elastic supply for a product is higher than if capital labour cannot easily be switched
*Time period and production speed
- Supply is more price elastic the longer the time period that a firm is allowed to adjust its production levels
- In some agricultural markets the momentary supply is fixed and is determined mainly by planting decisions made months before, and also climatic conditions, which affect the production yield
- In contrast the supply of milk is price elastic because of a short time span from cows producing milk and products reaching the market place
Income elasticity of demand (YED)
YED shows how responsive the demand for a product is to a change in (real) income
YED calculation
% change in Q.D ÷ % Change in income
Normal necessities and normal luxuries
- When YED is positive, a product is a normal good
- If following as increase in income, more of the good is demanded, then the good is a ‘normal good’
- Normal goods have a positive YED
Normal necessities:
- The products have a low but positive income elasticity - typically necessities such as milk and fruit
Normal luxuries:
- These products have a high and positive income elasticity - typically these are higher end products considered as a luxury by the relevant group of consumers
Inferior goods
- Inferior goods have a negative income elasticity of demand
- If following an increase in income less of the good is consumed then the good is an inferior good
- Such goods have a negative YED
- When real income are rising during a period of economic growth then the demand for inferior goods will fall causing an inward shift in the demand curve
- When real income are falling during a period of recession or if wages are rising more slowly than prices the demand for inferior goods will rise
- Inferior goods are sometimes called “counter-cyclical” products
Examples of luxury goods
- Luxury chocolates
- Exclusive resorts
- Business class travel
- Fine wine and dining
Examples of inferior goods
- Own label discounts
- Urban bus transport
- Cigarettes
- Economy class travel
Cross price elasticity of demand (XED)
XED measures the responsiveness of demand for good A to changes in price of good B
XED calculation
XED = % change in Q.D of good A ÷ % change in price of good B
Interpreting XED results
Positive XED
- Substitutes goods as price of good B rises quantity demanded of good A e.g. Pepsi and coke
Negative XED
- Complementary goods as price of good B rises quantity demand of good A falls e.g. bread and butter
XED summary
- The stronger the relationship between the two products the higher is the co-efficient of cross price elasticity of demand
- When there is a strong complementary relationship, the cross elasticity will be highly negative. E.g. games console and software
- Unrelated products have a zero cross elasticity e.g. the effect of changes of taxi fares on the market demand for cheese
