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BACHELOR OF HUMAN RESOURCE MANAGEMENTS

PRINCIPLES OF MICROECONOMICS
TABLE OF CONTENTS

TITTLE PAGES
1.0 INTRODUCTION (ELASTICITY) 2
2.0 PRICE ELASTICITY OF DEMAND 3-12
3.0 CROSS ELASTICITY OF DEMAND 13-14
4.0 INCOME ELASTICITY OF DEMAND 15-17
5.0 ELASTICITY OF SUPPLY 17-19
6.0 TAX BURDEN 20-22
7.0 BENEFITS OF SUBSIDIES 23

8.0 CONCLUSION 26

WHAT IS ELASTICITY?
Elasticity known as a measurement for sensitivity of a particular variable due to a
changes in one of the determinants (price, income). Elasticity also known as a concept
which includes probing how responsive demand (or supply) is to a change in another
variable such as price or income.In business and economics, elasticity states the degree to
which involves individuals, consumers or producers can change their demand or the
amount supplied in reaction to price or income changes. It is primarily used to evaluate
the change in consumer demand as a result of a change in a good or service's price.

In general, the value of elasticity can be calculated from:

PERCENTAGE CHANGEQUANTITY
ELASTICITY=
PERCENTAGE CHANGE DETERMINANT

Usually we calculate elasticity with percentage of change due to number of reasons such
as elasticity allows assessments to be made towards the change for two subjects
restrained in different units .For example, we can relate the change of quantity with the
change of price in the rate of currency. We also can elude the problem of defining the
size of units used. For example, an increase from RM 2 to RM 3 is considered as
increase of 1 price unit but change from 200 unit cents to 300 cents shows an increase of
100 price units. Turning it into the form of percentage, without considering the price units
being used the same value will be attained. Then, complete change is not able to define
whether a change is relevant or irrelevant. It can only be recognized if the initial
value is given. For example, the change of RM 1 for a good with an initial price of RM10
is considered relevant. But if the initial price of good is RM500 a change of RM1 is
considered as an irrelevant change. In other words, we look at the percentage of change
defining the size of price change. The concept of elasticity can be used by policy makers,
producers, and even consumers. For example, firms can use the elasticity concept to
define the substitution of resource utilisation when one of the input price increases. If
capital price decreases, firms can replace labour into capital but the rate of replacement is
defined by rate of elasticity.
TYPES OF ELASTICITY
There are four types of elasticity generally used specifically price elasticity of demand,
price elasticity of supply, income elasticity of demand and cross elasticity of demand.

PRICE ELASTICITY OF DEMAND


Price elasticity of demand is a measure of the affiliation between a change in the
quantity demanded of a certain good and a change in its price of the good. Price
elasticity of demand is a term in economics often used when discoursing price sensitivity.

The formula to calculate price elasticity of demand is:

Percentage ChangeQuantity Demanded


Price Elasticity of Demand =
Percentage Change Price

A 20 percent rise in price causes 40 percent reduction in quantity demanded, the price of
elasticity of demand is -40% / 20% = -2

The point elasticity is used to measures the value of elasticity on one point on a curve,
while arc elasticity is the average elasticity between two points on a curve.

ARC ELASTICITY
To measure the arc elasticity, we need to identify two points on the demand curve. In the
formula above, dQ/dP is the part derivative of quantity with respect to price, and P and Q
are price and quantity, respectively, at a specified point on the demand curve.

POINT ELASTICTY

To abridge the theory, we assume mid-point of the demand curve as a point (C) where
elasticity is unity (Ed=1). Elasticity of demand declines (Ed<1) when we move to the
exact direction from point C and upsurges (Ed>1) the other way around.

The value of elasticity can be measured using two methods, such as point elasticity and
arc elasticity or midpoint elasticity.

The formula to evaluate point elasticity is :


POINT elasticity of demand = measure Elasticity demand at two points.
Different elasticities at different points on straight line demand curve.
Mid point elasticity calculated using arc elasticity to measure two points on
one curve.
Point Ed = % Qd
% P

Q1 Qo X 100
Qo = Q X Po
= P Qo
P1 Po X 100
Po
Qo is the initial quantity and Q1 is the new quantity ,while PO is the initial price and P1 is
the new price. The symbol is used to signify change for example:

Q=Q1 Q0

The formula to measure arc elasticity (midpoint elasticity).


Arc elasticity used to calculate the average elasticity of an arc between two points on one
curve.

Q1 Qo X 100
Qo /2 = Q X (P1 + Po)
= P (Q1 + Qo)
P1 Po X 100
Po /2
THE DEGREES OF ELASTICITY

Some goods have very elastic demand, while others have less elastic demand. A minor
drop in the price of a goods may lead to a significant increase in the quantity demanded,
but occasionally even a substantial fall in price may not lead to any increase in demand.
Different goods have different price elasticitys. Some supplies have more elastic
demand while others have relative elastic demand. Essentially, the price elasticity of
demand varies from zero to infinity. It also can be equal to zero, less than one, greater
than one and equal to unity. According to DR. Alfred Marshall in the Principles of
Economics: Unabridged Eighth Edition book. The elasticity of demand in a market is
great or small conferring to the total demanded increases much or little for a
specified fall in price and reduces much or little for a specified growth in price. The
degree of elasticity of demand to small change in price varies according to goods.
PRICE ELASTICITY OF DEMAND, TOTAL REVENUE AND TOTAL
EXPENDITURE.

Total revenue in economics states to the total earnings from sales of a given quantity of
goods. It is calculated by multiplying the quantity of goods sold by the price of the goods.

The formula to evaluate Total Revenue:

Total Revenue = Price x Quantity Sold.

Total Expenditure = Price x Quantity Bought.

Total Revenue to producers = Total Expenditure by consumers.

FOR EXAMPLE:

PRICE X QUANTITY = TOTAL REVENUE.

5 X 10 =50
DEGREES OF ELASTICITY OF DEMAND

1. Perfectly Elastic Demand:


Perfectly elastic demand is said to occur when a little change in price indicate to an
infinite change in quantity demanded. A small increase in price on the part of the seller
decreases the demand to zero. In figure 1, the shape of the demand curve will be
horizontal straight line.

The ruling price OP, the demand is infinite. An insignificant increase in price will pact
the demand to zero. A slight decrease in price will attract more consumers but the
elasticity of demand will remain infinite (ed=). The cases of perfectly elastic demand
are exceptionally rare and not practical in the real world.

2. Perfectly Inelastic Demand:


In the perfectly inelastic demand, irrespective of any increase or fall in price of a goods,
the quantity demanded remains the unchanged. The elasticity of demand is equal to zero
(ed = 0).
In diagram 2 displays the perfectly inelastic demand. A price is OP, the quantity
demanded is OQ. When price falls to OP1, from OP, the demand remains the unchanged.
If the price increases to OP2 the demand still remains the unchanged. It is hard to see
cases of perfectly inelastic demand because even the demand for simple essentials of life
shows some degree of responsiveness to change in price.

3. Unitary Elastic Demand:


The demand is said to be unitary elastic when a given equivalent change in the price level
brings about an equal equivalent change in quantity demanded. The numerical rate of
unitary elastic demand is precisely one.
In figure 3, demand curve signifies unitary elastic demand. This demand curve known as
a rectangular hyperbola. When price is OP, the quantity demanded is OQ. When price
decreases to OP1 the quantity demanded increases to OQ2. The area OQ\RP = area
OP\SQ2 in the figure above.

4. Relatively Elastic Demand:


Relatively elastic demand refers to a situation where a slight change in price indicates a
vast change in quantity demanded. In this case, the elasticity of demand is more than one
(ed > 1).

In figure 4, the demand curve which specifies that price is OP and the quantity demanded
is OQ1. Now the price falls from OP to OP1, the quantity demanded rises from OQ 1 to
OQ2. The quantity demanded changes more than change in price.

5. Relatively Inelastic Demand:


In the relatively inelastic demand, a given percentage change in price produces a
relatively less percentage change in quantity demanded. The elasticity of demand is said
to be less than one (ed < 1).
All the five degrees of elasticity of demand have been illustrated in figure 6. On OX axis,
quantity demanded and on OY axis price is given.

It illustrates: ELASTICITY OF STRAIGHT-LINE DEMAND CURVE.


Different elasticity at different points on straight line demand curve
Elastic at higher prices
Unit elasticity at midpoint of demand curve
Inelastic at lower prices
Relationship with Total Revenue

1. AB Perfectly Inelastic Demand

2. CD Perfectly Elastic Demand

3. EG Less than Unitary Elastic Demand

4. EF Greater Than Unitary Elastic Demand

5. MN Unitary Elastic Demand

ELASTICITY OF DEMAND DETERMINANTS


1. Number of substitutes :
Close substitutes = elastic demand, increase in Price will lead to decrease in
Quantity as consumers shift to alternatives easily.
No close substitutes = inelastic demand, increase in Price will not decrease the
Quantity as consumers cannot find alternatives.
Budget ratio= proportion of Y spent on goods.
If large Percentage of Y spent on good, then increase in Price will lead large fall
in Quantity, then demand is elastic. For example, petrol, car.
If goods take up small Percentage of income spent, then demand is inelastic
even when there is an increase Price. The Quantity decreases. For example, salt.
2. Time period
In Short Run, demand becomes inelastic, when Price increase consumers do not
have enough time to look for alternatives or change taste so no change in
Quantity. For example, when P of petrol increase.
In Long Run, demand becomes elastic, consumers have time to switch to
alternatives. For example, switch to public transport, so when the price of petrol
increase the Quantity demanded will decrease.
3. Number of uses of goods
The more uses the particular good has, the more elastic the demand price.

CROSS ELASTICITY OF DEMAND

In economics, the cross elasticity of demand (cross-price elasticity of demand)


measures the responsiveness of the quantity demanded for a goods towards a change in
the price of another substitutes, ceteris paribus.
The formula for Cross elasticity is:

Percentage of changequantity demanded for good X


EXY =
Percentage of change price of good Y

Exy = % change in Qd for Gd X


% change in P of Gd Y
= Qx X Py
Py Qx

THE USE OF CROSS ELASTICITY OF DEMAND

Relationship
No Value/ Degree of Exy Examples between Good
Coefficient X and Good Y

1 Exy<0 Price X leads to Petrol & car Good X and


(-ve) Quantity demanded Y Flour and Bread Good Y are
Price X leads to Sugar and Coffee Complementary
Quantity demanded Y goods
2 Exy>0 Price X leads to Beef and chicken Good X and
(+ve) Quantity demanded Y Car and bus Good Y are
Price X leads to transport substitute goods
Quantity demanded Y
3 Exy=0 Price X will not have Good X and
any effect on Quantity Good Y are
demanded Y unrelated goods

INCOME ELASTICITY OF DEMAND


In economics, income elasticity of demand used to calculate the sensitivity of the quantity
demanded for a supply when there is an alteration in the income of the people demanding
for the supply, ceteris paribus. It is evaluated as the proportion of the percentage change
in quantity demanded to the percentage change in income.
Income elasticity calculated from:

Percentage Changequantity demanded


ELASTICITY=
Percentage of change income

Ey = % change in Qdx
% change in Y
= Q X Y
Y Q

When Y is income, the point elasticity formula of income elasticity is:


Q1 Q0 X 100
EY = Q0 = Q X Y0
Y1 Y0 x 100 Y Q0
Y0
And the midpoint elasticity formula is:
Q1 Q0 X 100
(Q1 + Q0)/2
EY= Y1 Y0 X 100 = Q X Y1 + Y0
(Y1 + Y0)/2 Y Q1 + Q0

THE USE OF INCOME ELASTICITY OF DEMAND

No Value/ Degree of Meaning Type of Goods Shape of Angels


Coefficien Income Curve
t Elasticity

1 Ev=0 Zero income Increase in Y will not Necessities. For


elasticity lead to increase in example, salt, sugar,
Quantity demanded soap, news paper
2 Ev>1 Y elastic Increase in Y will Luxuries. For
lead to a large example, car, house,
increase in Quantity holiday vacation
demanded (%Qd >
%Y)

3 0<Ev<1 Y inelastic Increase in Y will Normal goods


lead to a small
increase in Quantity
demanded (%Qd <
%Y)

4 Ev<0 Negative income Increase Y will lead Inferior goods. For


elasticity to fall in Quantity example, poor grade
demanded quality rice

PRICE ELASTICITY OF SUPPLY


Price elasticity of supply (PES or Es) used in economics to measure the sensitivity
of elasticity and the quantity supplied of a good towards price change.

The elasticity calculated from:

Percentage of changequantity supplied


ES =
Percentage of change price
Es = % change in Qs
% change in P
= Q X Po
P Qo
GRAPH OF ELASTICITY OF SUPPLY AT DIFFERENT TIME PERIODS.

QS Q

Very Short Run, Es = 0, (large) Price increase from Po to P3.


Short Run, Es < 1, Price increase from Po to P2.
Long Run, Es > 1, (small) Price increase from Po to P1.

DEGREE OF ELASTICITY OF SUPPLY

No Value/ Degree of Meaning Shape of Diagram


Coefficient Elasticity Supply curve
1 Es = 0 Perfectly % P does not lead to any Vertical
inelastic Qs (Qs is fixed)

2 Es < 1 Inelastic % P leads to small % Intersects with


Qs (%Qs <%P) quantity axis

3 Es = 1 Unitary/unit % P results in an equal Starts from the


elasticity %Qs origin
4 Es > 1 Elastic % P leads to large % Intersects with
Qs (%Qs> %P) price axis

5 Es = Perfectly % P results in an infinite Horizontal


elastic Qs (P is fixed)

DETERMINANTS OF PRICE ELASTICITY SUPPLY

1. SIZE OF INDUSTRY
Small industry are flexible in regulating production inputs, supply is relatively
elastic.
Large industry have large immovable inputs and difficult to adjusting production
size, supply is relatively inelastic.
2. Mobility of resources / production factors
Resources that are portable are easily substitutable with other uses or have more
than one use, supply is elastic.
For example, if production uses labor and labor can be replaced by machines,
supply becomes elastic.
For example, machinery of production of one good can be used to produce
another good, then supply is elastic.
3. Time period and production speed
Length of time producers take to adjust production or output.
Very short run firms not able to alter production, supply is fixed (perfectly
inelastic).
Short run-producers able to alter supply by adjusting some input. For example,
variable input such as labour, supply is inelastic.
Long run producers have sufficient time to vary production by changing all
input. For example, increase in plant and factory size, supply is elastic.

APPLICATION OF THE ELASTICITY CONCEPT

TAX BURDEN / INCIDENCE

Tax incidence refers to a person who ultimately bears the burden to pay the tax such as
the producer or consumer and the causing societal effect that. The tax incidence or tax
burden depends on the price elasticity of demand and price elasticity of supply.

Taxes are an important source of income for the government. Taxes can cause decrease in
both supply and demand in the market because buyers have to pay a higher price and
sellers obtain a lesser price for their product. The government attempts to divide the
burden of the tax such as payroll tax which is requiring both employer and employee to
pay of the tax, which, for 2013 onward, is 15.3% of wages paid.

How the elasticity of demand and supply does affects tax burden? For example, the
government decides that the buyer should pay the 10% tax for a packet of sugar. Does
this mean that the buyers will be paying 10% more, or the sellers have to share the tax
burden? The higher prices will cause the decrease in demand notwithstanding the reason
for the higher prices, sellers will have to share the burden of tax.

HOW TAX BURDEN IS DETERMINED BY THE ELASTICITY OF SUPPLY AND


DEMAND FOR THE PRODUCT.

If either demand or supply was perfectly elastic or inelastic, the tax burden will fall
entirely on either the buyer or the seller. The tax incidence difference can be seen in two
different case, where the tax burden be bear by the buyer if demand is inelastic or
supply is elastic, and tax burden will fall on the seller if demand is elastic or supply is
inelastic.

DOES A TAX SHIFT THE DEMAND OR SUPPLY CURVE?

A classic demand or supply curve illustrates the relationship between the price and the
quantity (demanded or supplied). If a demand or supply changes because of changes in
other demand or supply elements, it will cause a shift in the demand or supply curve,
where the quantity will be different for every price point.

Buyer's Tax Burden = Price Buyer Pays - Market Price without the Tax = Pb Pm

Seller's Tax Burden = Market Price without the Tax - Price Seller Receives = Pm Ps
In the 4 diagrams below, a tax on a specific goods increases its price and deduct the
quantity supplied, since suppliers are getting fewer revenue for their goods. The
calculated tax shifts the supply curve upward, from S to St, when the price increases from
P to Pt, and the quantity will decreases from Q to Qt. The buyer bears the tax burden
when either demand is inelastic or supply is elastic, as shown in diagrams # 1 and # 4,
respectively. When demand is elastic or supply is inelastic, then the seller bears the tax,
as shown in diagrams # 2 and # 3, respectively.
SUBSIDIES

A subsidy is a sum of money given to firms by the government to boost the production
and consumption. Subsidies can be presumed as a negative tax because it is a payment
made by government to retailers, consumers, producers and to anyone to endorse
production.

THE EFFECT OF SUBSIDY

The effect of a specific per unit subsidy is to shift the supply curve vertically
downwards by the sum of the subsidy. The new supply curve will be parallel to the
original. The effect to reduce price and increase the output depends on elasticity of
demand.
THE INCIDENCE OF A SUBSIDY

The economic incidence of a subsidy specifies who is made better off by the subsidy.
While, the legal incidence shows who is helped by the subsidy through law. In the
diagram below, the subsidy per unit is A B, and the new quantity disbursed is Q1.
The price paid by consumer
does not fall by the full sum
of the subsidy but it decrease
from P to P1. Even though
the purpose of the subsidy is
to reduce the price of
consumer by the full sum of
the subsidy. The producer
still gets some of the benefit
in terms of extra revenue. The gain of the consumer is P - P1 per unit, and the total gain
of the consumer is the area PFBP1.

The gain of the producer is C P per unit and the total gain of the producer is CAFP.
The total cost of the subsidy by the government is the area CABP1.

DIFFERENT TYPES OF PRODUCER SUBSIDY


1. A guaranteed payment on the element of a rate of a product. For example, a
guaranteed minimum price given to farmers such as under the Common Agricultural
Policy (CAP).
2. An input subsidy which subsidies the rate of inputs used in manufacture. For
example, an employment subsidy for taking on more workers.
3. Government grants to cover losses made by a business. For example, a grant given
to cover losses in the railway and airline industry.
4. Bail-outs. For example, financial organisations as the wake of the credit crunch
5. Financial assistance (loans and grants) for businesses setting up in areas of high
unemployment. For example, as part of a regional policy planned to improve
employment.

CONCLUSION

In conclusion, Market equilibrium is attained when demand is equivalent to supply. The


equilibrium quantity and price will not change when there is no change in demand and
supply. The market forces the supply and demand cooperate to bring the equilibrium
price by clearing the market of excess demand or supply. This can help market
mechanism to attain the constancy between the plans and outcomes for consumers and
producers without obvious coordination. The excess of demand or shortage can cause
increase in the price and excess in supply or surplus. This will results decrease in the
price. Equilibrium quantity and price can change when either the demand curve or supply
curve shifts or if there are shifts in both the demand curve and supply curve. The price
elasticity of demand evaluate the sensitivity of quantity demanded towards change in
price. The demand can be elastic, unitary elastic, inelastic, perfectly elastic or perfectly
inelastic depending on the value of coefficient evaluated. The bigger the value of
coefficient, the bigger the elasticity is. The core determinants of elasticity of demand are
the number of substitute goods available, time and the importance of the good in budget.
The income elasticity is the percentage of change in quantity divided by percentage of
change in income. The negative value is for inferior goods, zero for necessities and
positive for normal goods and luxury goods. Cross elasticity is the percentage of change
in the quantity of a good, divided by the percentage of change of alternative goods. If the
elasticity coefficient is positive both goods are said to be the substitute of one another but
if the elasticity coefficient is negative both goods are said to be the complementary of one
another. The elasticity of supply is the percentage of change in quantity supplied divided
by percentage of price change. The main determinants of elasticity of supply are time
factor, change in production cost and mobility of production factors. Among the
application of elasticity concept is in determining the actual burden for tax and the actual
benefits from subsidies.

3801 words

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