Understanding price elasticities of demand and supply is crucial for analyzing how changes in price affect the quantity demanded or supplied. The formula for calculating price elasticity of demand (PED) is given by:
$$ \text{PED} = \frac{\text{Percentage Change in Quantity Demanded}}{\text{Percentage Change in Price}} $$
Similarly, price elasticity of supply (PES) follows the same formula structure. It's important to note that the results of these calculations are always expressed as positive numbers, using absolute values. If the elasticity value is greater than 1, the demand or supply is considered elastic, indicating that quantity changes significantly with price changes.
When calculating elasticities, the two primary variables involved are quantity and price. For income elasticity of demand (YED), the formula is:
$$ \text{YED} = \frac{\text{Percentage Change in Quantity Demanded}}{\text{Percentage Change in Income}} $$
For cross-price elasticity of demand (XED), the formula is:
$$ \text{XED} = \frac{\text{Percentage Change in Quantity Demanded of Good X}}{\text{Percentage Change in Price of Good Y}} $$
Analyzing the results of YED and XED requires attention to the signs of the values. A positive YED indicates a normal good, while a negative value suggests an inferior good. For XED, a positive result indicates that the goods are substitutes, whereas a negative result indicates they are complements.
Additionally, the concept of the midpoint method is essential for calculating elasticities accurately, especially when dealing with larger changes in price and quantity. This method helps in determining the elasticity over a range of values rather than at a single point.
When examining a straight-line demand curve, it is important to identify the point that maximizes total revenue. To the left of this midpoint, demand is elastic, while to the right, it is inelastic. At the midpoint, demand is unit elastic, meaning that total revenue remains constant with price changes. If the price increases and total revenue also increases, this indicates inelastic demand.
By consolidating these concepts, students can effectively prepare for assessments on elasticity, ensuring a comprehensive understanding of how price changes impact market behavior.
