Demand and supply
Demand and supply are the foundations of any economic analysis as the interaction of the two forms a market. The law of demand and supply works in the divergent ways in the sense that, when the prices of commodities changes, demand and supply will change in opposite direction holding other factors constant.
Market equilibrium for is attained at the point of intersection of demand and supply curve. Equilibrium condition is not static as any factor which affects demand and supply may distort it. The demand or supply of some goods will respond more to changes in price as compared to others.
This brings us to the concept of elasticity of goods. In addition, it is not only price that affects demand and supply of goods, there are other factors that would affect the market such as changes in technology, income, climatic conditions, and government regulations such as taxes.
This paper carries out the calculation of price elasticity of demand and income elasticity of a commodity. It further carries out the computation of market forecasts.
Price elasticity of demand
Elasticity is a measure of responsiveness of demand or supply to changes in market condition. Price elasticity of demand measures the sensitivity of quantity demanded of a commodity to a unit change in the price of the commodity holding other factors affecting demand constant.
An increase in the price of a commodity results to a decline in quantity demanded. A commodity has a perfectly inelastic demand curve when the price elasticity of demand equals to zero one (0 < PED < 1). For inelastic demand, the price elasticity lies between zero and one.
Elastic demand has an elasticity that lies between one and infinity. A calculation of price elasticity of demand is shown below.
Ed = [(Q2 – Q1) / (P2 – P1)] * [(P1 +P2) / (Q1 + Q2)]
= (111,000 – 106,000) / 145 – 150) * (150 + 145) / (111,000 + 106,000)
= (5,000 / -5) * (295 / 217,000)
= -1.3594
The arc price elasticity of demand of the commodity is -1.3594. This shows that the commodity has elastic demand. That is, the percentage change in quantity demanded changes is more than a unit change in the price of the commodity.
Income elasticity of demand
Income elasticity of demand measures the sensitivity of changes in quantity demanded of goods and services to change in real income of the people consuming the goods and services, holding other factors constant. For a normal good, the income elasticity of demand is positive.
Computation of income elasticity of the commodity is shown below.
Ed = [(Q2 – Q1) / (I2 – 11)] * [(I1 +I2) / (Q1 + Q2)]
= (111,000 – 106,000) / 358,786 – 361,381) * (358,786 + 361,381) / (111,000 + 106,000)
= (5,000 / -2,595) * (720,167/ 217,000)
= -6.3945
The arc income elasticity of demand for the commodity is -6.3945. Negative income elasticity of demand implies that the commodity is an inferior good. This implies that if income declines by one unit, quantity demanded will increase by 6.3945 units.
Market forecast
Market forecast will be obtained by multiplying the price elasticity of demand and income elasticity of demand as shown below.
Market forecast = price elasticity of demand * Income elasticity of demand
= -6.3945 * -1.3594
= 8.6926