Types of Elasticities in Economics and Their Calculation

This document explains the three types of elasticities in economics - price elasticity of demand, price elasticity of supply, and cross elasticity of demand. It provides detailed explanations of how to calculate each type of elasticity and discusses the usefulness of elasticities in decision-making. The document also discusses the components of aggregate demand (GDP) and evaluates whether GDP is a good measure of the well-being of a nation.

Economics

Table of Contents
Question 1:.......................................................................................................................................1
(a) Explain in detail three types of elasticities in economics and how it can be calculated........1
(b) Critically evaluate the usefulness of the concept of elasticities.............................................4
Question 4:.......................................................................................................................................6
(a) Explain each of the components of aggregate demand (GDP) giving an example of each...6
(b) Is GDP a good measure of the well-being of a nation? Discuss............................................8
REFERENCES..............................................................................................................................10

Question 1:
(a) Explain in detail three types of elasticities in economics and how it can be calculated
Elasticity can be defined as measurement of percentage in terms of change in one variable,
in terms of changes in other. It refers to central concept within economics, which helps in
analysing the economic variables like income, demand and price (Lee and Seshadri, 2019). In
general, four types of elasticity are present, which helps in measuring the relationship between
significant economic variables. It includes –
Price elasticity of demand (PED) – This factor shows relationship between quantity and
price, by using the formula –
PED = % change in quantity demanded
% change in price
Through this calculated value, effect of changes in price on demanded quantity as well as
on revenue received by companies (Giroud and Rauh, 2019). If PED is measured as less than one
then it shows demand is inelastic, while greater one shows elastic. In addition to this, zero value
shows product is perfectly inelastic and undefined value as perfectly elastic.
Price elasticity of supply (PES) – This elasticity helps in measuring the
responsiveness of quantity which is supplied at marketplace as per change in
price (Bhattacharyya, 2019). By calculating PES, firms get able to quickly and
effectively, respond towards changes in market conditions, particularly for
price changes. It can be calculated by using following formula –
PED = % change in quantity supplied
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% change in price
The value of PES defines three extreme cases as Perfect elastic in which supply of
product is available in enough quantity at fixed price. While perfectly inelastic shows that only
one quantity at marketplace can be supplied (Jalili and et. al., 2019). Other than this, the last case
of PES i.e. unit elasticity supply as per demand of particular good.
Cross elasticity of demand (XED) – This elasticity helps in measuring the changes in
demand of one product as per fluctuation of pricing policy of another good. If price of a good is
increased then demand of its substitutes or alternative ones will be increased (Beck and Lein,
2019). Thus, calculating value of XED helps firms in determining price policy and respond
towards changes in price of competitive goods. It can be calculated by using below formula –
XED = % change in quantity demanded (one product
% change in price of second good
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Income elasticity of demand (YED) – It measures responsiveness of quantity demanded
within change in customer incomes, or effect of change within income on quantity demanded. As
income is considered as main determinant of consumer demand, so, YED shows the extent at
which any fluctuations in income will increase or decrease in demand (Balatsky and Ekimova,
2019). In general, companies use this microeconomic concept in forecasting the sales; make
decision to raise or lower price of products as per change in income of consumers. It can be
calculated by dividing percentage change in demanded quantity to percentage change in income.
YED = % change in quantity demanded
% change in income
Through calculation, a product is a necessity or luxury can be decided, where positive
value represent the high demand and negative value decrease in demanded quantity. Therefore,
depending on income elasticity of demand’s value, goods or services can be broadly categorized
in terms of inferior and normal.
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Thus, all of these concepts of microeconomics help in highlighting main areas, where
government and organisation can take actions of developing economy and meet customers
demand on time (Hobijn and Nechio, 2019). It includes determination of output level;
determination of price; price discrimination by monopolists; price determination of production
factors; demand and sales forecasting; etc.
(b) Critically evaluate the usefulness of the concept of elasticities
Since law of demand states that a higher price may decrease the demanded quantity and law
of supply shows increase in same. Therefore, to make decision regarding with how much price
can be increased with less impact on equilibrium point, firms can use different applications of
elasticity (Lee and Seshadri, 2019). It helps in measuring responsiveness of change in one
variable as per other. Law of demand and supply helps in determining relationship between
quantity and price, but it fails to provide extent of degree related to impact of change in price to
supplied or demanded quantity. Therefore, to understand responsiveness degree, concept of
elasticity can be used. For this purpose, given formula can be applied to understand the
relationship between price and quantity of product –
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Elasticity = % change in quantity demanded/supplied
% change in price
Elasticity in economics demonstrates the change in buyers’ behaviour of buyers and sellers
for a good or service, due to fluctuation in change in price (Giroud and Rauh, 2019). It helps in
firms in deciding whether demand of a product is elastic or inelastic, then developing pricing
policies to gain profitability. An inelastic product in this one shows high willingness of
consumers to purchase a particular product even on any price. While elasticity of a product or
service may vary as per availability and presence of number of substitutes or alternative ones,
including their relative cost. Companies which operate in highly competitive area gain
opportunity to offer products and services that are elastic, according to their choice
(Bhattacharyya, 2019). In this regard, firms are tended to be price-takers, where the time at
which price of their goods reached at point of elasticity, the buyers and sellers quickly make
adjustment in demand for the same. Therefore, concepts of elasticity are highly important for
both both buyers and sellers, as it reflects consumption of products by buyers as per changes in
price. In this sense, products or services which are elastic may be unnecessary or might easily be
replaced with its alternative ones.
While in context with government, elasticity as economic measure helps in deciding the
fixed price of goods or services, which need to be exported in international market (Beck and
Lein, 2019). With inelastic demand, a country can trade its products at higher price, however,
demand of same can be elastic at domestic market. Along with this, price elasticity of demand is
majorly helpful for government in formulating taxation and other economic policies. Through
analysing the elasticity of products, higher tax can impose on inelastic ones and lower on elastic
commodities. Similarly, Income elasticity of demand proves beneficial for government in setting
price for domestic goods and services (Balatsky and Ekimova, 2019). For example – Rise in
wages increase capabilities of people in spending money to buy goods for fulfilment of their
necessities. While income inelasticity of demand helps government authorities’ in considering
tax and spending policies. Other than this, price elasticity of supply proves highly important for
government in taking decision on supply of public utilities. It is especially vital in terms of
spending money public housing projects, in which supply of houses mainly depends on
allocation of space. In general, a reduction in price reduction tends to increase in demanded
quantity (Hobijn and Nechio, 2019). But, with housing sector, it may contradict the fact because
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it is considered as a basic necessity of people, where they are ready to pay more for purchasing a
house (Jalili and et. al., 2019). Therefore, in such condition, government used to increase housing
supply where both prices and demand are high, as well as stimulating the consumers demand
also, with development of economy.
Question 4:
(a) Explain each of the components of aggregate demand (GDP) giving an example of each
The term aggregate means total demand of finished domestic products or service at
marketplace in an economy. As per the law of demand, people buys commodities more when it is
available at affordable or lower price. Therefore, government always try to provide domestic
goods at reasonable price for them, so that economy can be developed (Kotz, 2019). For this
purpose, five main components are taken into account that helps in measuring aggregate demand.
It includes – consumer spending (C), government spending (G), difference between export (X)
and import (M) and business spending or capital investment (I) by using the below formula –
AD = C + I + G + (X – M)
Using the above formula, economists can estimate how much capital is being spent on a
product by all businesses, government, consumers, overseas firms and people (Dabla-Norris and
et. al., 2020). To analyse this macroeconomic term, it is essential to understand role of each
component first in increasing aggregate demand as explained below –
Consumer’s spending (C) on goods and services – This term also known as consumption
which includes demand for a good, which users willing to re-purchase again and again. Mainly
the term consumers’ spending compromises with expenditure on household goods, which are
characterised in terms of durable, semi-durable and non-durable (Braunstein, Bouhia and
Seguino, 2020). For example: vehicles are durable goods, while food and drinks are non-durable
ones. But consumption of such goods are depended only on disposable income and MPC
(marginal propensity to consume).
Capital Investment (I) – This term includes expenditure which is incurred by firms on
purchasing of raw materials, goods, labours, machine and more, for production of goods. Here,
investment of capital mainly depends on relative value of Rate of Return & Rate of Interest
(Bieler, Jordan and Morton, 2019). In addition to this, it also spends on working capital like
stocks of finished or semi-finished products, new buildings, equipment and more, for producing
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more goods in future to meet demand. In context with UK, over 75% of capital investment on
consumer goods are spent by private organisations like British Airways, Tesco, M&S and more.
Therefore, private sector as compared to public ones, contributes major role in enhancing GDP
and ultimately economy at high level (Bachmann and Zorn, 2020).
Government spending (G) – It spends on state-provide services and goods for satisfying
basic necessities of people, like public hospitals, government schools, infrastructure development
and more (Solomon, 2019). It generally depends on priorities of government, which shift demand
from taxpayers to beneficiaries, therefore, doesn’t include transfer of payments such as social
security, job-seekers allowance etc.
Export of goods and services (X) – It includes goods which are export in overseas
market, where net export (import – export) depends on factors like Foreign Trade policy,
comparative prices and quality etc.
Import of goods and services – It includes goods which are imported from overseas
market to meet consumers’ demand.
Thus, all these components drive economy of a nation by increasing aggregate demand of
domestic products or services (Silva, 2019). The demand curve in this sense, shows quantity of
demanded product at each price and how it changes as per fluctuation in prices, as illustrated
below –
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(b) Is GDP a good measure of the well-being of a nation? Discuss
The term GDP i.e. Gross domestic product is one of the wide concept of macroeconomics
which mainly use for measuring the output or production of national economy. It defines as total
value of domestic goods or services which are produced in a specified time period (monthly,
quarterly and annually). In other words, it measures both total income and expenditure of
economy on goods and services (Dabla-Norris and et. al., 2020). In this sense, with rise in GDP,
economy of a nation also increases continuously, which depends on aggregate demand of
domestic goods at market. For this purpose, both government and private sector companies focus
on increasing export in overseas market and decrease export as much as possible, so that
consumers’ demand could be met by domestic production. Along with this, as GDP shows
market value of finished goods and services, which are produced within a country therefore, each
single products contributes in boosting economy and measured by its market price (Bachmann
and Zorn, 2020). In this regard, to analyse if GDP is a perfect tool for measuring the economy, it
is essential to determine if predictable factors influence the economic activity. It includes
household expenditure, capital investment by firms, government purchasing and net export. By
linking these predictable factors with economy, GDP of a country can easily be measured, in
terms of total economic output by consumers, business and government (Bieler, Jordan and
Morton, 2019). This would be a tangible way for quantifying the economic state. As per Kotz
(2019), GDP measures well-being of an economy by analysing the income level or purchasing
power of people which depends on their disposable income. So, it is highly correlated with these
measures of well-being, that are employment, life expectancy of people, disposable income and
more, that capture some aspects of life-quality (Is GDP a good measure of economic activity and
well-being?, 2017). Life expectancy of people reflects that a nation having overall mortality level
of population is good then it indicates general health. Therefore, if a country has good life-
expectancy then it helps in increasing consumption of household goods, which ultimately leads
to increase GDP.
GDP thus, considers as good indicator of population standard of living, but it doesn’t
directly account for environmental quality, leisure, changes in inequality of income at micro
level, education level and activities that is conducted outside the market, or positive and negative
value which society place on certain types of output (Braunstein, Bouhia and Seguino, 2020). It
doesn’t measure the actual level of cleanliness of environment, level of inequality in income or
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in society etc. Therefore, these concept argues that GDP is not a perfect measure for analysing
well-being state of economy at macro level.
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REFERENCES
Books and Journals
Bachmann, R. and Zorn, P., 2020. What drives aggregate investment? Evidence from German
survey data. Journal of Economic Dynamics and Control, p.103873.
Balatsky, E. V. and Ekimova, N. A., 2019. The Impact of Tax Reforms on the Behaviour of
Economic Agents (Indirect Taxation in Russia and the USA). Journal of Tax
Reform. 5(2). pp.129-147.
Beck, G. W. and Lein, S. M., 2019. Price elasticities and demand-side real rigidities in micro
data and in macro models. Journal of Monetary Economics.
Bhattacharyya, S. C., 2019. Energy economics: concepts, issues, markets and governance.
Springer Nature.
Bieler, A., Jordan, J. and Morton, A. D., 2019. EU Aggregate Demand As a Way out of Crisis?
Engaging the Post‐Keynesian Critique. JCMS: Journal of Common Market
Studies. 57(4). pp.805-822.
Braunstein, E., Bouhia, R. and Seguino, S., 2020. Social reproduction, gender equality and
economic growth. Cambridge Journal of Economics. 44(1). pp.129-156.
Dabla-Norris, E. and et. al., 2020. Supplement to'Distinguishing Constraints on Financial
Inclusion and Their Impact on GDP, TFP, and The Distribution of Income'. Journal of
Monetary Economics, Forthcoming.
Giroud, X. and Rauh, J., 2019. State taxation and the reallocation of business activity: Evidence
from establishment-level data. Journal of Political Economy. 127(3). pp.1262-1316.
Hobijn, B. and Nechio, F., 2019. Sticker shocks: using VAT changes to estimate upper-level
elasticities of substitution. Journal of the European Economic Association. 17(3). pp.799-
833.
Jalili, H. and et. al., 2019. Modeling of demand response programs based on market elasticity
concept. Journal of Ambient Intelligence and Humanized Computing. 10(6). pp.2265-
2276.
Kotz, D. M., 2019. The Rate of Profit, Aggregate Demand, and the Long Economic Expansion in
the United States since 2009. Review of Radical Political Economics, 51(4), pp.525-535.
Lee, S. Y. and Seshadri, A., 2019. On the intergenerational transmission of economic
status. Journal of Political Economy. 127(2). pp.855-921.
Silva, M. R., 2019. Corporate finance, monetary policy, and aggregate demand. Journal of
Economic Dynamics and Control. 102. pp.1-28.
Solomon, E., 2019. The Impact of Public Expenditure Components on Economic Growth in
Ethiopia; Vector Autoregressive Approach. International Journal of Business and
Economics Research. 8(4). p.211.
Online
Is GDP a good measure of economic activity and well-being?. 2017. [Online] Available
Through:< https://www.grin.com/document/205712 >.
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