Supply & Demand: Elasticity, Factors, and Market Analysis
Supply and Demand
Demand
Demand: The quantity of a good or service that consumers are willing and able to buy at various prices within a given time period, other factors besides price held constant.
Note: Changes in price lead to movement along the demand curve; changes in non-price factors lead to shifting of the demand curve.
Factors That Can Cause Demand to Change:
- Taste and Preferences
- Income
- Prices of Related Products
- Future Expectations
- Number of Buyers
Supply
Supply: The quantity of a good or service that producers are willing and able to sell at various prices within a given time period, other factors besides price held constant.
Note: Quantity supplied is directly related to price, other factors constant; demand is inversely proportional to price, while supply is directly proportional to price.
Non-Price Determinants of Supply:
- Costs and Technology
- Price of Other Goods and Services Offered
- Future Expectations
- Number of Sellers
- Weather Conditions
Market Analyses
An increase in demand causes equilibrium price and quantity to rise.
A decrease in demand causes equilibrium price and quantity to fall.
An increase in supply causes equilibrium price to fall and quantity to rise.
A decrease in supply causes equilibrium price to rise and quantity to fall.
Short-Run and Long-Run Changes in the Market
| Initial Change (SR) | Follow-On Change (LR) |
|---|---|
| Increase in demand causes price to rise. | Supply increases as new sellers enter the market and original sellers increase production capacity. |
| Decrease in demand causes price to fall. | Supply decreases as less profitable firms or those experiencing losses exit the market or decrease production capacity. |
| Increase in supply causes price to fall. | Demand increases as tastes and preferences of consumers eventually change in favor of the product relative to substitutes. |
| Decrease in supply causes price to rise. | Demand decreases as tastes and preferences of consumers eventually change away from the product toward substitutes. |
Elasticity
Factors Affecting Demand Elasticity:
- Ease of Substitution
- Proportion of Total Expenditures
- Durability of Product
- Possibility of Postponing Purchase
- Possibility of Repair
- Used Product Market
- Length of Time Period
Relationship Between Price Elasticity and Total Revenue (TR)
| Elastic | Unitary Elastic | Inelastic | |
|---|---|---|---|
| Price Increase | TR↓ | TR (no change) | TR↑ |
| Price Decrease | TR↑ | TR (no change) | TR↓ |
Cross-Elasticity
Cross-elasticity: Deals with the percentage impact on the quantity demanded for a particular product created by a change in the price of a related product. It measures the percentage change in quantity demanded of product A resulting from a 1% change in the price of product B.
The sign of cross-elasticity for substitutes is positive; for complements, it is negative.
Two products are considered good substitutes or complements when the coefficient is larger than 0.5.
Income Elasticity
Income elasticity: Measures the percentage change in quantity consumed resulting from a 1% change in income.
- Income elasticity > 1: Superior goods
- Income elasticity ≥ 0 and ≤ 1: Normal goods
- Income elasticity < 0: Inferior goods
Advertising Elasticity
Advertising elasticity: The percentage change in quantity demanded caused by a 1% change in advertising expense.
Arc Elasticity
Arc elasticity: Elasticity measured over a discrete interval of a demand (or supply) curve.
Coefficient of Elasticity
Coefficient of elasticity: The percentage change in one variable divided by the percentage change in the other variable.
Complementary Good
Complementary good: A product consumed in conjunction with another. Two goods are complementary if the quantity demanded of one increases when the price of the other decreases.
Derived Demand
Derived demand: The demand for products or factors that are not directly consumed but go into the production of a final product or factor. This demand exists because there is demand for the final product.
Inferior Good
Inferior good: A product whose consumption decreases as income increases (income elasticity < 0).
Marginal Revenue
Marginal revenue: The change in total revenue resulting from changing quantity by one unit.
Point Elasticity
Point elasticity: Elasticity measured at a given point on a demand (or supply) curve.
Price Elasticity of Demand
Price elasticity of demand: The percentage change in quantity demanded caused by a 1% change in price.
Price Elasticity of Supply
Price elasticity of supply: The percentage change in quantity supplied as a result of a 1% change in price.
Substitute Good
Substitute good: A product that is similar to another and can be consumed in place of it. Two goods are substitutes if the quantity consumed of one increases when the price of the other increases.
Price Ceiling
Price ceiling: A government-imposed limit on the price at which a product can be sold. Products cannot be sold at prices higher than those prescribed by the government.
Price Floor
Price floor: A government-imposed minimum price at which a product or service can be sold. For example, the legal minimum wage is a price floor.