Elasticity of Demand vs Elasticity of Supply
Similar in meaning to the expansion of a rubber band, elasticity of demand/supply refers to how changes in X (which can be anything such as price, income, raw material prices, etc.) can affect the quantity demanded or quantity supplied. In price elasticity of demand (PED) and price elasticity of supply (PES), we look at how changes in price can affect the quantity demanded or the quantity supplied. The article offers a clear overview of PED and PES and highlights their similarities and differences.
What is Elasticity of Demand?
Price elasticity of demand shows how changes in demand can occur with the slightest change in price. Price elasticity of demand is calculated by the following formula.
PED = % change in the quantity demanded / % change in the price
There are different levels of elasticity depending on how responsive quantity demanded is to change in price. If PED = 0, this shows perfectly inelastic situation where demand will not change at all with any changes in price; examples are necessities, addictive goods. If PED < 1, this is still inelastic because change in quantity demanded is lower than the respective change in price (large change in price will result in a small change in quantity demanded). If PED > 1, this shows price elastic demand where a small change in price will result in a large change in quantity demanded; examples are luxury goods, substitute goods. When PED = 1, the change in price will have an equal change in quantity demanded; this is called unitary elastic.
A number of factors can affect PED such as the availability of substitutes (demand is more elastic with more substitutes as now consumers can switch to butter if the price of margarine increases), whether the product is a necessity (demand inelastic) or luxury (demand elastic), whether the good is habit forming (such as cigarettes – demand is inelastic), etc.
What is Elasticity of Supply?
Price elasticity of supply shows how changes in price can affect quantity supplied. Price elasticity of supply is calculated by the following formula.
PES = % change in the quantity supplied / % change in the price
When PES > 1, supply is price elastic (small change in price will affect quantity supplied). When PES < 1, supply is price inelastic (large change in price will have a small effect on quantity supplied). When PES = 0, supply is perfectly inelastic (a change in price will not affect quantity supplied), and PES = infinity is when quantity supplied will not change, regardless of the price.
There are a number of factors that can affect PES such as spare production capacity (supply elastic), availability of raw materials (raw materials scarce, supply inelastic), time period (longer time period – supply is elastic as the firm has enough time to adjust factor of production and increase production), etc.
Elasticity of Supply vs Elasticity of Demand
Price elasticity of demand and price elasticity of supply are concepts closely related to one another as they consider how demand or supply will be affected by changes in price. The two are, however, different as PED looks at how demand will change and PES considers how supply will change. The other major difference between elasticity of demand and elasticity of supply is that demand and supply respond differently to an increase/decrease in price; demand tends to increase when price falls, and supply tends to fall when price falls. This means that if PED is elastic, a small increase in price will cause a large decrease in quantity and if PES is elastic a small increase in price will cause a large increase in quantity supplied.
Summary:
• Price elasticity of demand and price elasticity of supply are concepts closely related to one another as they consider how demand or supply will be affected by changes in price.
• Price elasticity of demand shows how changes in demand can occur with the slightest change in price. Price elasticity of demand is calculated by, PED = % change in the quantity demanded / % change in the price.
• Price elasticity of supply shows how changes in price can affect quantity supplied. Price elasticity of supply is calculated as, PES = % change in the quantity supplied / % change in the price.
• One major difference between elasticity of demand and elasticity of supply is that demand and supply respond differently to an increase/decrease in price; demand tends to increase when price falls, and supply tends to fall when price falls.