SUPPLY

Supply is the willingness and ability of

producers to make a specific quantity of
output available to consumers at a particular
price over a given period of time.
Law of supply

 A decrease in the price of a good, all

other things held constant, will cause a
decrease in the quantity supplied of the
good.
 An increase in the price of a good, all
other things held constant, will cause an
increase in the quantity supplied of the
good.
Supply Determinants
Sx = F( Px , Py, Pz,……;P,O,T)

Sx = Amount of good x supplied

Px = Price of good x

Py,Pz = Prices of other goods in the

market

P = Prices of factors of production

o = Objective of the producer

T = State of technology
Factors on which supply depends

 Important shift factors of supply are

 Changes in the prices of inputs used in production of a good
 Changes in technology
 Changes in suppliers expectations
 Changes in taxes and subsidies
 Each of these shift factors will cause a shift in supply, whereas a
change in price causes a movement along the supply curve.
 The major variables other than price are
 Nature of the commodity
 Limited supply of inputs
 Events beyond human control like good/bad harvest,
weather conditions and natural disasters like floods.
 Government restriction on quantity to be produced .
Elasticity of supply

 It is defined as the ratio of percentage change in quantity demanded and the

percentage change change in the price of the commodity.
 Change
Es = change in price
in quantity Quantity
Price
Elasticity
 The responsiveness of one variable to
changes in another
 When price rises, what happens
to demand?
 Demand falls
 BUT!
 How much does demand fall?
Elasticity
 If price rises by 10% - what happens to
demand?
 We know demand will fall
 By more than 10%?
 By less than 10%?
 Elasticity measures the extent to which
demand will change
Elasticity . . .

◆ … is a measure of how much buyers

and sellers respond to changes in market
conditions
◆ … allows us to analyze supply and
demand with greater precision.
◆Journal Question-Name 3 necessities
and 3 luxuries that you would buy.
Determinants of Elasticity
 Time period – the longer the time under
consideration the more elastic a good is likely to
be
 Number and closeness of substitutes –
the greater the number of substitutes,
the more elastic
 The proportion of income taken up by the
product – the smaller the proportion the more
inelastic
 Luxury or Necessity - for example,
addictive drugs
Types of Elasticity

 Price elasticity of demand

 Income elasticity of demand
 Cross elasticity
 Promotional or Advertisemsent

 Measurement of Elasticity :

 POINT METHOD
 ARC METHOD
Point Method
Point elasticity: Elasticity measured at a
given point of a linear demand (or a
supply) curve.

dQ P1
εP = x
dP Q1
Arc Method
Arc elasticity: Elasticity which is
measured over a discrete interval of a
demand (or a supply) curve.

Q2 − Q1 P2 − P1
Ep = ÷
(Q1 + Q2 ) / 2 ( P1 + P2 ) / 2

Mid Point
Formula
Question 2.
A firm increases the price of product A, from
50p to 60p, demand falls from 1000 units a
week, to 900 units a week. What is the Price
elasticity of demand of the product?
A. 2
B. 1.5
C. 0.5
Ed > 1 ⇒ elastic demand (very
responsive
to price changes).

Ed< 1 ⇒ inelastic demand (not very

sensitive to prices).

Ed = 1 ⇒ unitary elastic (ratio of %∆s = 1).

 Price Elasticity of Demand
◆ Price elasticity of demand is the
percentage change in quantity demanded
given a percent change in the price.

◆ It is a measure of how much the quantity

demanded of a good responds to a
change in the price of that good.
 Computing the Price Elasticity
of Demand
The price elasticity of demand is computed
as the percentage change in the quantity
demanded divided by the percentage
change in price.

Price Elasticity = Percentage Change in Qd

Of Demand Percentage Change in Price

 Determinants of
Price Elasticity of Demand
◆ Necessities versus Luxuries
◆ Availability of Close Substitutes
◆ Time Horizon
◆ Weightage in total consumption
◆ Range of usage of good .
 Perfectly Elasticity of Demand
y

‘x’ axis = ‘quantity’ demanded

x ε = α ‘y’ axis = ‘price’

x 1 x 2
x
In this case, price reduction is not required to increase the quantity
demand.
ε=α
The producers need not concentrate on price reduction
activities to improve the sales if his good comes under the perfectly
elasticity of demand.
 Perfectly Inelasticity of Demand
y

P 0

P E=0
P1
X= units of goods demand.
Y= price of the commodity
D
x

In this case, even though the price of commodity decreases,

the demand remains the same. ε= ‘0’
The producers need not increase or decrease the price of the
commodity to bring change in demand .
 y Unitary Elasticity of Demand

P 0
E= 1
P
P1
D
X= units of goods demand.
Y= price of the commodity
x

x
x 0
x1
This is a very rare phenomenon that occurs in a business where
the demand increases equally with the increase in price.
 Relatively Elasticity of Demand
y

E>1
P 0

P
P1
D
X= units of goods demand.
x Y= price of the commodity

x
x 0 x 1
ere is a minimum reduction in price and
e demand increases rapidly. So a small
ange in price increases the quantity
manded to large extent to a producer .
:Cell Phones ,Gold.
 Relatively Inelasticity of Demand
y

E<1
P 0

P1
P
D X= units of goods demand.
x Y= price of the commodity

x
x 0x 1
Even though there is huge decrease in price, the quantity demanded
increase only a little.
E.g.: Inferior Goods
Example:
P0 = 8 P1 = 7
Q0 = 40 Q1 = 48

Step 1: ∆Q = 48 - 40 = 8
∆P = 7 - 8 = -1

Step 2: Use the formula for Ed.

Step 3:

Ed = (∆Qd / ∆P) * P0 / Q0

= (8 /-1) * (8/40) = - 1.6

Step 4:

This means that for every 1 % change in

price that there is a 1.6 % change in
quantity demanded in the opposite
direction.
 Income Elasticity
• Income Elasticity of Demand
◆ Income elasticity of demand
measures how much the quantity
demanded of a good responds to a
change in consumers’ income.
◆ It is computed as the percentage
change in the quantity demanded
divided by the percentage change in
income.
 Computing Income Elasticity

Percenta ge Cha ng e
Inc ome Ela st ic it y = in Qua nt ity Dema nded
of De mand Perce nta ge Cha nge
in Inco me
 Income Elasticity
- Types of Goods -
◆ Essential Income Elasticity is positive.
◆ Elasticity is less than one (Ey <1)
Comforts
Elasticity equal to unity (Ey =1)
Income Elasticity is equal to unity .
◆ Luxuries
◆ Elasticity is greater than unity (Ey>1)
Income Elasticity of Demand
 Normal goods are divided into luxuries
and necessities.
 Normal Good – demand rises as income
rises and vice versa

YeD mantra…
+ = normal
- = inferior!
Income Elasticity of Demand
 Luxuries are goods that have an income
elasticity greater than one.

 Theirpercentage increase in demand is

greater than the percentage increase in
income.
Income Elasticity of Demand
 Inferior goods are those whose
consumption decreases when income
increases.
 Inferior goods have income elasticities
less than zero.
Income Elasticity of Demand:
 Normal Good – demand rises as income
rises and vice versa

 Inferior Good – demand falls as income

rises and vice versa
Look out for the sign…!
 A positive sign (+) denotes a normal good

 A negative sign (-) denotes an inferior

good
Positive Income Elastic Demand
Diagram
Negative Income Elasticity
Diagram = Inferior
Zero Income Elasticity
 This occurs when a
change in income
has NO effect on
the demand for
goods.

 A rise of 5%
income in a rich
country will leave
the Demand for
toothpaste
 - Negative Income
Elasticity
• An increase in income will result in a
decrease in demand.

• A decrease in income will result in a

rise in demand.

• ALSO known as INFERIOR GOODS

 Look for the signs!
NORMAL GOODS • LUXURY GOODS

+ BETWEEN 0 & 1
+0.5 +0.9 + 0.1 + GREATER THAN 1
+2 +5 +27

INFERIOR GOODS

- CAN BE A DECIMAL OR A VALUE

GREATER THAN 1
Income Elasticity and the
Demand for Airline Travel
 Demand for air travel has a positive
income elasticity of demand
 The industry is cyclical
 During an upturn, demand rises for
business and leisure travel)
 During a recession, the demand tails
away
Income elasticity will vary according to the
type of air travel
 E.g. difference between low-cost “no-
frills” and higher priced scheduled
services on low-haul flights
Income Elasticity of Demand
for Chocolate
Which country has
the sweeter tooth
when it comes to
Total consumption income elasticity for
 USA 0.79 chocolate??

 Germany 0.39
 United Kingdom 0.44
 France 0.60
 Japan 0.08
 Switzerland 1.06

Reference: Henri Jason Trends in cocoa and chocolate consumption with

particular reference to developments in the major markets. Malaysian
International Cocoa Conference, Kuala Lumpur, (ICCO, ED(MEM) 686)
USES OF INCOME ELASTICITY

 It is useful in demand forecasting ,When a change in personal

income is expected .

 It avoids over or under production.

 It helps to define the good as normal or inferior good

PROBLEMS

 A consumer demands 4kgs of sugar when his income is Rs 2,000.

When his income went up to Rs 2,400 ,demand for sugar increased
to 5 kgs . Calculate Ye of demand and state whether it is elastic or
inelastic in nature ?

 2) If a consumer ‘s demand for a good increases from 100units to

200 units per week when his income rises from Rs 2000 to Rs
3000,Find income elasticity of demand ?

1.2 , 2
 Cross-Price Elasticity
Measures how sensitive DEMAND
for a commodity is to changes in
the price of a substitute or
compliment commodity
Cross- Elasticity of Demand
 Cross- elasticity of demand – the
percentage change in demand divided by
the percentage change in the price of
another good.
 Complements and
Substitutes
• Substitutes are goods that can be
used in place of another.
• Substitutes have positive cross-price
elasticities.
Complements and Substitutes
 Complements are goods that are used in
conjunction with other goods.
 Complements have negative cross-price
elasticities.
 Let us assume that two commodities X ‘n’
Y are related the expression of cross elasticity
of demand would be

E xy = ∆qx × py
∆py qx
 Same formula is used for both substitutes and
complementary goods

 For substitutes cross elasticity is positive

 For complements cross elasticity is negative

 If the goods are non related i.e., neither

substitutes nor compliments C.E.D is zero
 Problem
The price of coffee increases from Rs 50per kg to Rs
70 per kg AS A RESULT THE DEMAND FOR TEA
INCREASES FROM 5 Kg to 10 kgs .What is the cross
elasticity of demand of tea for coffee ?
∆P coffee =Rs 70-Rs 50 = Rs 20

∆Qtea = 10kg- 5Kg =5Kg

E xy = ∆qTea . pCoffee
∆pCoffee qTea.
Problem
 A and B are rival products .The price of A
decreases from Rs 200 to Rs 150 .The
demand for B decreases from 100units to
80 units .Calculate cross elasticity of
demand ?
 Promotional Elasticity
• Measures the responsiveness of
demand to changes in
advertisements or promotional
expenses .
• It is very useful for producers to
calculate the change in sales as a
result of change in advertisement
expenditure .
• It depends on stage of products
development .
 FORMULA
• Ea = ∆S. A
• ∆A. S
S = Sales

A= Initial Advertisement cost

∆S = change in Sales

∆A = Change in Advertisement cost

Importance of Elasticity
 Relationship between changes
in price and total revenue
 Importance in determining
what goods to tax (tax revenue)
 Importance in analysing time lags in
production
 Influences the behaviour of a firm