2.4 concepts of elasticity and use of labour demand elasticity

8/6/2019 2.4 Concepts of Elasticity and Use of Labour Demand Elasticity.

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Concepts of elasticity and use of labour demandelasticity.

2.4

ELASTICITY:

Elasticity measures the degree of responsiveness of one variable to the variations in

another variable. In general, the elasticity of any function is defined as the percentagechange in the dependent variable that is caused by a one percent change in one

independent variable while all other variables are held constant.

TYPES OF DEMAND ELASTICITY:

We may distinguish between the three types of elasticity, viz.,

1. Price elasticity;

2. Income Elasticity and

3. Cross elasticity.

PRICE ELASTICITY OF DEMAND

Price elasticity of demand measures the degree of responsiveness of quantity demanded for

a commodity to a change in the price of that commodity. It can be computed by the

formula stated below.

Since the law of demand inversely relates price and quantity demanded, so in the above

formula the numerator and denominator always have opposite algebraic signs, and the

price elasticity of demand is always negative. In practice, the minus sign is often ignored or

omitted, and only the absolute value of this elasticity is reported for business decision-

making.

Use of Price elasticity: Knowledge of price elasticity of demand for a commodity is very

useful for its producers, and others dealing with that, in support of business decision-

making. If the manager were aware of the elasticity for his commodity, he would know

whether a change in price would be worthwhile or not in respect of demand, revenue and

profit.

Knowledge of price elasticity will also guide the firm to ascertain whether its sales proceeds

would increase, decrease or remain invariable in the face of price variations. This, in turn,

would help a businessman to decide whether he should cut or raise his price in a particular

case. In general, for items with elastic demand, decision comes to relatively low variation in

prices, while items with inelastic demand, decision may comes to higher variation in price

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considering other conditions. Furthermore, the knowledge of price elasticity of demand

would enable the firm to estimate the likely demand for its product at different prices.

Interpretation of Elasticity:

The coefficient of elasticity determined by either the point or arc formula consists of two

components: magnitude (= < > in respect to one) and sign (+ or -).

The magnitude (absolute value) of the coefficient indicates the degree of sensitivity of the

dependent variable to change in the independent variable, i.e.

If IEI > 1, the function is elastic, meaning that a 1 percent change in the

independent variable will cause greater than a 1 percent change in the dependent

variable. For example, price elasticity of demand for a relatively steep demandcurve,

If IEI = 1, the function is unit elastic, meaning that a 1 percent change in the

independent variable will cause a same 1 percent change in the dependent variable.

For example, price elasticity of demand for a relatively flat demand curve,

If IEI < 1, the function is inelastic, meaning that a 1 percent change in the

independent variable will cause less than a 1 percent change in the dependent

variable.

The two extreme magnitude of the elasticity are

If IEI = 0, the function is perfect inelastic, for example, price elasticity of a vertical

demand curve where the quantity demanded is not at all price sensitive, such as,

some of the life saving medicines.

If IEI = , the function is perfect elastic, for example, price elasticity of a horizontal

demand curve where the quantity demanded is highly (infinity) sensitive of price.

The sign indicates the relative direction of movement between the two variables. If the sign

is negative, they are inversely related and move in opposite directions. If it is positive, they

move in the same direction.

(PRICE) ELASTICITY OF SUPPLYThe price elasticity of supply measures the percentage change in quantity supplied in

response to a 1 percent change in the goods price. i.e.,

priceininchange%

suppliedquantityinchange%=ES

We can readily see that the definition of price elasticity of demand and price elasticity of

supply are exactly same. The only difference is that, for supply, the quantity response to

price is positive, while that response is negative in case of demand.


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2.4

Demand Elasticity of (labor) resource

The elasticity of resource demand is defined as:

The price elasticity of demand for a (labour) resource is expected to be higher when:

the price elasticity of demand for the final product is relatively high,

this resource accounts for a relatively large share of the firm's total costs,

there are many substitutes for the resource, and

a longer time period is considered.

Let's consider why the price elasticity of demand for the final product affects the priceelasticity of resource demand. Resource demand is more elastic when the quantity of theresource demanded declines by a larger amount when the price of the resource declines.Let's examine how a change in the resource price affects the quantity of the resourcedemanded. As the price of the resource rises, marginal and average total costs of

production will increase. This increase in costs results in a higher equilibrium price of theproduct being sold. As the price of the product rises, the quantity of the product demanded

declines. Since the demand for resources is a derived demand, this decline in the quantityof the product demanded results in a reduction in the quantity of resources demanded.

When the price elasticity of demand for the final product is relatively large, there will be alarger reduction in the quantity of the final product demanded (and therefore a largerreduction in the quantity of resources demanded) when the price of a product rises inresponse to an increase in resource price. Be sure to think through the chain of causalityrather carefully to understand the relationship between the price elasticity of demand forthe product and the price elasticity of resource demand.

The resource's share in total costs affects the elasticity of resource demand in a similarmanner. When the price of the resource rises, the effect on marginal and average total

costs will depend upon the resource's share in total costs. If a resource comprises 10% oftotal costs, a doubling of the price of the resource would result in a 10% increase in total

costs. If the resource accounts for only 1% of the firm's cost, a doubling of it's price willraise the firm's costs by only 1%. Thus, a change in the price of the resource will have alarger effect on the cost of and the price of the final product when the resource is a largershare of total costs. In this situation, the quantity of output sold will decline by more, aswill the quantity of the resource demanded. Thus, resource demand is more elastic whenthe resource accounts for a larger share of total costs.

Firms will reduce the employment of a resource by a larger amount when many substituteresources are available. Thus, resource demand is more elastic when there are moresubstitutes.

Since it takes time for firms to alter their production methods, an increase in the price of aresource will have a larger effect in the long run when there are more possibilities forsubstitution. Thus, resource demand will be more elastic when a longer time period is

considered.


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2.4

Elasticity of labour supply to an occupation

The elasticity of labor supply measures the extent to which labor supply responds to a

change in the wage rate in a given time period. In low-skilled occupations we expect thelabor supply to be elastic. This means that a pool of readily available labor is employable at

a fairly low market wage rate.

Where jobs require specific skills and lengthy periods of training, the labor supply will be

more inelastic. It is hard to expand the workforce in a short period of time.

In many professional occupations there are barriers to the entry of new workers. Examples

include Law, Accountancy and Medicine. The need for high-level educational qualificationsmakes the supply of newly qualified entrants to these occupations quite inelastic in the

short run and is one reason why these workers may earn higher than average salaries.

The total supply of labor available to produce goods and services is a key factor

determining how much output an economy can generate. The governments wants toexpand the active labor supply through its various policies and also take initiatives toincrease the productivity of the work-force to improve international competitiveness. Bothobjectives are long-term aims

2.4 concepts of elasticity and use of labour demand elasticity

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