Back to basics Part 3 - Price Elasticity of demand

What is Price elasticity of demand?

• The price elasticity of demand is the measurement of the responsiveness of demand to a change in price.
• The formula for price elasticity of demand (PED) is - 

• The value range of PED:
• PED = 1: Unit elastic, Change in price results in a proportionally equal change in quantity demanded.
• PED = 0: Perfectly inelastic, change in price results in no change in quantity demanded.
• PED = ∞: Perfectly elastic, a change in price results in a infinitely large change in demand.
• 0 < PED < 1: Inelastic demand: A change in price results in a proportionally small change in demand.
• PED > 1: Elastic demand: A change in price results in a proportionally larger change in demand.
• IMPORTANT NOTE: 
• You may have noticed that all values are negative, but assume that for the above PED equations, the value of PED is positive absolute value.
• The case where PED = 0 or ∞, are completely theoretical and cannot exist in the real world. 
• Graphs for the above cases: 

• Factors affecting PED - 
• The number and closeness of substitutes
• The necessity of the product and how widely the product is defined
• Time period considered

Back to Basics Part 2: Supply

What is Supply?

• Supply is the willingness and ability of producers to produce a quantity of goods and services at a given price at a given time period. 
• The law of supply states that, as price increases, the quantity supplied of the product will increase, ceteris paribus. 
• An example could be the market of frozen pizzas. The following graph demonstrates the rule above.

• This happens because at higher prices there will be more potential profits to be made and so the producer will increase output. 

• Factors affecting supply other than price - 
• The costs of factors of production
• The state of technology
• Expectations
• The price of other products which the producer could produce instead of the existing product.
• Amount of Government intervention
• A change in any of these factors (other than price) will shift the supply curve, for example:

Back to Basics Part 1 : DEMAND

What is demand? 

• Demand is the quantity of goods or services that consumers are willing and able to purchace at given prices over a given time period.
• The law of demand states that, as the price of a good falls, the quantity demanded of therpoduct will usually increase, ceteris paribus. (Ceteris paribus is an assumption  that means "all other things being equal")
• An example is the soft drink market. The following graph demonstrates the rule above. 

• As you can see, when the price falls, the demand increases. This is for 2 reasons-
• Income effect- When the price of a product falls, the people will have an increase in their real income, which reflects the amount that their income will buy. 
• Substitution effect- When the price of the product falls, it will be relatively more attractive to people than other goods.
• Factors affecting demand other than price- 
• Income
• Price of other products
• Taste and preferances
• Advertisement
• Population and Age structure
• Other factors such as government policies, etfc.
• A change in any of these factors (other than price), will shift the demand curve, for example:

Supply Side Policy

Supply Side Policies are government attempts to increase productivity and shift Aggregate Supply (AS) to the right.

How do supply side policies work?

Supply side policies aim to increase the long run aggregate supply. This can be done by increasing the quality or quantity of factors of production. Here are a few ways of achieving this - 

1) Increase in training & education - Education is under-provided by the market as it is a merit good. Therefore, governments increase the quality and quantity of training and education by either providing the education themselves or by subsidising companies.

2) Reduction in direct taxes (eg. income tax) - Lower taxes may provide workers with an incentive to work even harder.

3) Improvements in Infrastructure - Improving trasnport and roads will reduce costs of firms which means they invest that in increasing the quality and quantity of their supply.

4) Privatisation - It is argued that private sector firms are more efficient as they have different goals, than the state sector counter parts, which forces them to be more productive. 

5) Reducing the power of Trade Unions - This increases the efficiency of firms and reduce unemployment because trade unions force higher wages. 

6) Deregulation - This invlolves reducing legal barriers to entry (eg. laws) which increase competition as more firms are able to enter the market. Additionally, Monopoly power can be reduced by restricting anti-competitive behaviors.

Advantages of Supply side policices.

1) Lower Unemployment

2) Higher Economic Growth

3) Reduction in the rate of Inflation.

Disadvantages of Inflation.

1) Involves extremely high costs

2) Takes a lot of time to implement.

3) Depends on the initial level of economic activity.