Elastic and inelastic demand, concept of elasticity

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2020-07-02 22:44:08

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The Demand – is the amount of goods or services that buyers are willing to buy at current prices over a certain period of time. Between the demand for the product and its price there is the following dependence: the higher the price, the fewer consumers are willing to buy it, and Vice versa. This dependence is called the ‘law of demand”.

However, economists and analysts it is not enough just to predict, how will the quantity demanded change in current prices. More important is the degree of this change. The force with which the change of demand depending on various factors is called "elasticity of demand”. There are several types of such elasticity: price, cross and income elasticity. Every type has its own characteristics.

Price elasticity shows how the demand varies depending on price fluctuations and is expressed through the coefficient of elasticity

Ed = (∆Q/Q): (∆P/P), where

ΔQ/Q-the change in the number of items to be purchased,

ΔP/P – changes in the cost of the product.

Also a measure of elasticity of demand can be calculated in percentage terms:

Ed = %Q/%P

%Q & ndash; the percentage increase or decrease in demand

%R & ndash; the percentage increase or decrease.

This ratio shows how demand will change if the price of the goods increases or decreases by 1%.

Cross-elasticity, in turn, indicates the level of demand for the first product depending on fluctuations in the value of the other. The formula of this indicator is as follows:

Eab= (∆Qa/Qa): (∆Pb/Pb), where

ΔQa/Qa – changes in the demand for the first product and, %;

ΔPb/Pb – change the second item of b, %.

The income Elasticity similar to the elasticity for the price, however, the role of the factor influencing the level of demand is income.

Ei = (∆Q/Q): (∆I/I), where

ΔQ/Q-the change in the number of goods sold

ΔI/I – relative change of income.

Depending on the obtained ratio there are the following types of elasticity:

1. Ed = 0.

In this case we have a completely inelastic demand. A zero coefficient means that price fluctuations do not affect the number of purchased goods. As a rule, it is an indispensable medical drugs, e.g., insulin.

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2. Ed < 1.

If the resulting value is in the range from 0 to 1, this means inelastic demand. Consequently, the price increases a little impact on sales. If the firm decides to reduce the margin on goods with inelastic demand, instead of the expected increase in sales it will get lower revenues. Examples of goods with inelastic demand are food products and commodities.

3. Ed = 1.

When unit elasticity, the price change will not affect the amount of revenue. It is in this case has a maximum size. An example is the demand for various transportation services, which tends to vary equally with the fluctuation of the cost of travel.

4. Ed > 1.

The elasticity of demand, which is significantly dependent on price fluctuations. Firms that sell such goods, it is recommended to reduce the prices of their products, since this will increase the income from the sale.

5. Ed = ∞.

This means that the demand for this product is characterized by absolute flexibility. With stable prices there is a periodic change in the demand for these products. An example of such products can serve as luxury items.

Elastic and inelastic demand is influenced by various factors. The most important of them are:

• number of substitutes of such goods. If a product has many good substitutes, the elasticity will be high;

• the specific weight of the product in income of the buyer. Dependence directly proportional: the higher the proportion, the higher the elasticity;

• the importance of the product for the consumer – whether a luxury item or is it an everyday product. Certainly, the demand for luxuries is more elastic.

• the time factor. The more time the buyer has, the higher the elasticity.

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