Journey in Learning Economics Part 3

Law of supply and Demand: The concept of elasticity.

Supply and Demand do not always and mostly wary in the same ratio as that of the price of the object. Percent change in the amount of commodity supplied divided by the percent change in price of the commodity. If the price of commodity changes by 10 percent and it leads to more than 10 percent change in commodity supplied or demanded then we may say that the demand or the supply is elastic. When the percent change in supply or demand is less than the percent change in price of commodity than we may say that the demand or supply is inelastic. When the percent change of x percent in price always corresponds to percent change of x in quantity demanded or supplied then the demand or supply is said to be elastic. 

These laws may be better understood with the help of some concrete examples. Let us take example of orange juice. The demand of this product is pretty elastic. If the price of orange juice increases by say 10%, people can easily substitute other products for it. They can stop drinking it without feeling much effect on their health or they may even start preparing it at home to avoid extra cost. So the reduction in demand of orange juice will be more than 10 % , say 20%. In this case, passing over the increased cost to consumer may mean that the net revenue of the producer may decrease because less no. of people would be willing to buy it. So, in such cases, where the demand of the good is pretty elastic, the burden of increased cost has to be borne by the producers of such goods. At the other end of the spectrum we have cigarettes, the demand of cigarettes among regular smokers is quite inelastic. So a 10% change in the price would lead to say merely like 3% change in the demand.  An increase in price of cigarettes would not decrease its consumption among habitual smokers to the same extent but will have a resisting effect upon young adolescent smokers who are not yet habituated. Thus increasing tax upon the cigarettes does little to deter those who are already addicted to it, whereas it does help in reducing the new preys of this deadly habit.

 

These concepts are immensely significant and very powerful tools of analysis in both macro and micro economic situations. If a firm wants to increase its profit, it can not arbitrarily resort to a blind increase in prices. The increase in price would increase revenues only when the demand of the product is inelastic. Salt is a good example. A product used by british imperialists to tax and fill their coffers because, it is next to impossible to do without salt or to substitute it with something else. So inelastic is the demand of salt that it can easily be considered worst form of taxation to single out this product. Whereas if the demand is elastic, increase in price is likely to prove counter productive. 

Our daily lives are replete with such examples. Will the increase in minimum wage result in increase in unemployment is literally a question of elasticity of demand of unskilled labour in the labour market. To put it differently, if the demand is inelastic, special professionals and technicians without which it is difficult to do without.  It may perhaps explain the skyrocketing remunerations of certain professionals. 

 

Another facet of the pull and push of demand and supply is the rule that quantity demanded and supplied remains inelastic in the short turn and will become elastic over the course of time. If suppose Petrol prices are completely deregulated then suddenly the prices would increase and neither the quantity supplied or demanded will increase or decrease immediately. It is difficult to set up alternate production units and substitute other goods for gasoline. However, in due course, people will shift towards more fuel efficient methods of using petroleum products, for e.g. by shifting to fuel efficient cars, car pooling, or using public transport instead. Thus in long run demand of the product will decrease.  Increased price of petrol, on one hand causes immediate discomfort and a higher inflation. But in due course, substitution occurs and the inflationary pressure exerted by the increased price eases out. Increased prices also provide an incentive to conserve. Thus taxing carbon fuels is possibly one of the best incentive to motivate people to shift from Ambassador to Swift, from oil guzzlers to more fuel efficient cars. 

 

This is it

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