Introduction
Elasticity of demand refers to the “degree to which quantity demanded changes due to a change in price or any other factors that influence the demand for the product” (Hall 2). There are three types of elasticity of demand which include price elasticity of markets, income elasticity of markets, and cross elasticity of markets.
The banking industry generates its income mainly from charging interest rates when lending loans and mortgages, foreign exchange dealings, and other money market factors.
Price Elasticity of Markets in the Banking Industry
Price elasticity of markets “refers to the degree of change in quantity demanded or supplied of a commodity due to a change in price of the commodity” (Hall 10) The formula is:
P.E.D = proportionate change in quantity demanded or supplied
Proportionate change in price
Price elasticity of markets in the banking industry influences such issues as foreign exchange, housing, mortgages and also issues of lending rates.
For example, the housing industry consists of houses that are already in the markets for sale, and those buyers would be willing to purchase. Factors that influence the economy would influence the lending rates to be used. If there is an excess demand for the homes, prices would increase, as a result. Since people always purchase hoses, it makes the price elasticity to be highly elastic.
When factors influencing the economy, such as inflation, grow, the lending rate has to be increased to discourage people from borrowing. The general prices would also increase due to the inflation, thus, lowering the quantity demanded.
Mortgage interest rates affect the price elasticity of houses. When the prices are low, consumers demand more homes since they don’t shy away from the prices that are offered. Price elasticity of markets influences interest rates, and would influence the monetary and fiscal policies. Interventions of monetary and fiscal policies may have an effect of a downturn or may boost the economy depending on the lending rates.
Income Elasticity of Markets
Hall describes income elasticity of markets as the responsiveness of the quantity demanded and supplied due to the change in the consumer’s real income while keeping other factors constant (p, 10). It is calculated as
Y.E.D=proportionate change in quantity demanded
Proportionate change in income
The income elasticity of markets has an effect on the deposit and lending decisions of the economy. Households earning high incomes would deposit more in both the depository and non depository institutions. Factors of the banking industry influencing spending ability, such as taxation and lending rates would have major influences.
An increase in interest rates would stimulate more savings and people would spend less. Interest rates also have an effect on the cost of funding operating debt schemes, such as bank loans and mortgages. For instance, an increase in the lending rates will shift the funds of consumers towards the high mortgage and loan payments, and they would shy away from spending.
Cross elasticity of markets
Hall calls cross elasticity as the responsiveness of quantity demanded of a product x due to change in price of related product y. These products can either be substitutes or complementary (13).
Consumers are increasingly choosing to obtain loans from non-depository institutions. According to the current statistics, only 41 % of consumer loans were taken from depository institutions. This shows the substitution effect of cross elasticity of markets (13).
Bibliography
Hall, Pamela. Microeconomic Theory in Markets. New York: Penguin, 2009. Print