2024 SAJC JC1 H1 Price Mechanism and its Applications Part 2 Lecture Notes

1 Important concepts and tools of analysis  Price Elasticity of Demand (PED)  Price Elasticity of Supply (PES)  Consumer Expenditure and Producer Revenue Key questions to consider 1. What is the definition and formula for price elasticity of demand (PED)? 2. What does the sign and magnitude of PED mean? 3. What are the determinants of PED? 4. How can the understanding of PED be applied in real world? 5. What is the definition and formula for price elasticity of supply (PES)? 6. What does the sign and magnitude of PES mean? 7. What are the determinants of PES? 8. How can the understanding of PES be applied in real world? 9. What are the limitations of the use of elasticity concepts? The theme on Price Mechanism and its Applications provides an understanding of the various elasticity concepts and how they can be applied in the real-world context to explain the implications of differing degrees of elasticity on price and non -price decisions. For example, you will learn how changes in prices of a product affect a firm’s sales and revenue. ST ANDREW’S JUNIOR COLLEGE JC1 H1 ECONOMICS 2024 Price Mechanism and its Applications Part 2

PRICE MECHANISM AND ITS APPLICATIONS PART 1: DEMAND, SUPPLY & PRICE DETERMINATION 2 Contents Important concepts and tools of analysis ................................................................................................... 1 Key questions to consider ........................................................................................................................ 1 INTRODUCTION ..................................................................................................................................... 3 1. PRICE ELASTICITY OF DEMAND (PED) ................................................................................................... 4 1.1. Definition & Formula .................................................................................................................... 4 1.2. Characteristics of Price Elasticity of Demand (PED) .......................................................................... 5 1.2.1. Values of Price Elasticity of Demand (PED) ........................................................................ 5 1.2.2. Graphical Representation of Price Elasticity of Demand ..................................................... 5 1.2.3. Relationship between Price Elasticity of Demand and Total Revenue .................................... 7 1.3. Determinants of Price Elasticity of Demand (PED) .......................................................................... 11 1.4. Application of Price Elasticity of Demand (PED)............................................................................. 14 1.4.1. Application by Producers .............................................................................................. 14 1.4.2. Application by Government ........................................................................................... 16 2. Price Elasticity of Supply (PES) ........................................................................................................... 20 2.1. Definition & Formula .................................................................................................................. 20 2.2. Characteristics of Price Elasticity of Supply (PES)........................................................................... 20 2.2.1. Values of Price Elasticity of Supply (PES) ........................................................................ 20 2.2.2. Graphical Representation of PES ................................................................................... 20 2.3. Determinants of Price Elasticity of Supply (PES) ............................................................................. 21 2.4. Applications of Price Elasticity of Supply (PES) .............................................................................. 24 3. Limitations of Elasticity Concepts......................................................................................................... 27 4. Annex A ........................................................................................................................................... 29 4.1. Varying Price Elasticity of Demand Along a Straight-Line/ Linear Demand Curve ............................ 29 4.2 Applications of Price Elasticities of Demand and Supply to Analyse Incidence of Taxes & Subsidies .... 30

PRICE MECHANISM AND ITS APPLICATIONS PART 2: ELASTICITIES OF DEMAND AND SUPPLY 3 INTRODUCTION In the previous topic, we have seen that the demand for and the supply of a good or service depends on changes in price and non-price determinants. Changes in price can affect the quantity demanded for or quantity supplied of a good or service. Changes in the non-price determinants (factors other than the price of the good or service) can affect the demand for or the supply of a good or service. From these relationships examined in the earlier topic, we know the direction of change in the quantity demanded and quantity supplied of a good or service when its price changes. These relationships, however, do not reveal the extent of the change in quantity demanded/supplied of a good or service when its price changes. For example, if the price of oil changes by 1 per cent, what will the extent of the change in quantity of oil demanded/supplied be? Similarly, we would also want to add more depth to our understanding by looking at the extent of the changes in demand and whether there is likely to be a large or small impact on equilibrium. For example, in some cases, a small increase in income may have a big impact on demand and this in turn may have a significant impact on the equilibrium price. In other cases, the same increase in income may have a little impact on demand and the market equilibrium. Elasticity concepts help us understand the changes more precisely. Elasticity is a way of quantifying cause and effect relationships. It is generally a numerical measure of the responsiveness of one dependent economic variable (effect) following a change in another independent variable (cause), ceteris paribus. Where relationships are elastic (responsive), a small change in the cause or independent variable has a large effect on the dependent economic variable. Where the relationships are inelastic (less responsive), a large change in the cause has a limited effect on the dependent variable. RECALL A decrease (increase) in the price of a good or service will lead to an increase (decrease) in quantity demanded for a good or service, ceteris paribus. In contrast, a decrease (increase) in the price of a good or service will lead to a decrease (increase) in quantity supplied of a good or service, ceteris paribus.

PRICE MECHANISM AND ITS APPLICATIONS PART 2: ELASTICITIES OF DEMAND AND SUPPLY 4 1. PRICE ELASTICITY OF DEMAND (PED) Key Question 1: What is the definition and formula for price elasticity of demand (PED)? 1.1. Definition & Formula It can be computed using the following formula. Price Elasticity of Demand (PED) = % change in quantity demanded for Good X % change in price for Good X = ∆𝑸𝒅 𝑸𝒅𝟎 × 𝟏𝟎𝟎% ∆𝑷 𝑷𝟎 × 𝟏𝟎𝟎% Where Qd = (Qd1 – Qd0) Qd1 = new Qd, Qd0 = original Qd P = (P1 – P0) P1 = new P, P0 = original P When the price of wheat increases from $4 to $5, the quantity of wheat demanded falls from 100kg to 60kg, ceteris paribus. In this case, the price elasticity of demand for wheat Price Elasticity of Demand (PED) = % change in quantity demanded for Good X % change in price for Good X = ∆𝑸𝒅 𝑸𝒅𝟎 × 𝟏𝟎𝟎% ∆𝑷 𝑷𝟎 × 𝟏𝟎𝟎% Price elasticity of demand measures the degree of responsiveness of the quantity demanded for a good or service to a given change in its price,