Application of Elasticities
Elasticity is a fundamental concept in economics, measuring how responsive one variable is to a change in another. In this chapter, we explore four types of elasticities: Price Elasticity of Demand (PED), Price Elasticity of Supply (PES), Income Elasticity of Demand (YED), and Cross Elasticity of Demand (XED). These concepts are critical for understanding real-world market dynamics and are especially relevant for students pursuing A Level Economics tuition.
1. Scenarios Leading to Sharp Changes in Prices
1.1 Demand Curve Shifts When Supply is Price Inelastic
When supply is price inelastic, an increase in demand leads to a steep rise in prices because producers cannot quickly increase output.
Example: Housing markets in Singapore. Due to limited land and slow construction processes, a rise in demand causes property prices to surge.
1.2 Supply Curve Shifts When Demand is Price Inelastic
If demand is price inelastic, even a slight reduction in supply results in a sharp price increase.
Example: Oil prices. A sudden drop in oil production (e.g., due to geopolitical conflict) leads to a significant price increase as demand remains stable.
1.3 Demand or Supply Shifts When Both Are Price Inelastic
When both demand and supply are inelastic, any shift in either curve results in extreme price changes.
Example: During the COVID-19 pandemic, limited supply of masks and high demand caused prices to rise dramatically.
2. Factors Explaining Large Changes in Price or Output
2.1 Qualitative Analysis
Understanding price and output changes requires considering several qualitative factors:
Nature of the good: Essentials like electricity are more prone to price volatility when supply is constrained.
Market conditions: Monopolistic markets, such as diamond mining, experience larger price swings due to limited competition.
2.2 Elasticities Analysis
Elasticities provide a quantitative way to analyze price and output changes:
If demand is inelastic: A leftward shift in supply results in a significant price increase but a small decrease in quantity.
If supply is inelastic: A rightward shift in demand results in a sharp price increase and limited output expansion.
Example Analysis:
The 2008 oil price spike occurred because of inelastic supply and rising global demand.
Agricultural markets experience sharp price swings due to inelastic supply and weather-related disruptions.
3. Key Diagrams and Graphs
Inelastic Supply Curve with Rightward Demand Shift: Steep price increase.
Inelastic Demand Curve with Leftward Supply Shift: Prices spike significantly.
Both Demand and Supply Inelastic: Extreme price volatility with minimal quantity changes.
4. Real-World Case Studies
4.1 Housing Markets
Land-scarce cities like Singapore and Hong Kong experience high housing prices due to inelastic supply.
Government policies, like cooling measures, influence demand and stabilize prices.
4.2 Oil Market
Geopolitical events, such as conflicts in oil-producing regions, disrupt supply and cause price spikes.
4.3 Healthcare Industry
During the COVID-19 pandemic, high demand for medical supplies like ventilators, coupled with inelastic supply, drove up prices globally.
5. Summary
Elasticity measures the responsiveness of demand and supply to changes in price, income, and the prices of related goods.
Sharp price changes often occur when supply or demand is inelastic.
Elasticities, combined with real-world analysis, are essential for understanding price and output fluctuations.