The newsLINK Group - Supply and Demand

Editorial Library Category: Mining Topics: Mining, Supply, Demand Title: Supply and Demand Author: newsLINK Staff Synopsis: Budgets have at least two categories: things people have to buy all the time, like food, and things people choose to buy when it suits them, like books or music. There’s overlap between the two; most people obviously have to buy food, but they can make choices about what goes in the shopping cart. Editorial: Supply and Demand 4064 South Highland Drive, Millcreek, Utah 84124 │ thenewslinkgroup.com │ (v) 801.676.9722 │ (tf) 855.747.4003 │ (f) 801.742.5803 Editorial Library | © The newsLINK Group LLC 1 Budgets have at least two categories: things people have to buy all the time, like food, and things people choose to buy when it suits them, like books or music. There’s overlap between the two; most people obviously have to buy food, but they can make choices about what goes in the shopping cart. And some purchases occupy a middle ground, where people will have to spend money eventually but the timing is optional. Think a house, a car, and clothing. Elasticity of demand is connected to discretionary spending: raising the price causes a drop in sales. If the price of a movie ticket goes up too high, for example, then fewer people will buy one. Suppose that changing the price of one product affects whether people buy a second product. The price relationship is called either cross-price elasticity or cross elasticity of demand. If the cost of gas goes up 10 percent, people might find a new, more economical car. If the demand for gas guzzlers decreases 20 percent, you would find cross elasticity of demand by dividing the decrease in sales (-20 percent) by the increase in the cost of gas (10 percent) to get an answer of –2. If the cross elasticity of demand is a negative number, the price increase of the first item and the demand for the second item are called complements because the items are used with each other. If the cross elasticity of demand is a positive number, the price increase of the first item and the demand for the second item are called substitutes because when the price of gas goes up, the buyer can decide to get a car that reduces or eliminates the need for gas. Why? Think of it this way. Gas-guzzling cars use gas; the two complement each other. If the price of gas goes up, the use of gas-guzzling cars goes down. But suppose that instead of a gas-guzzling car, a buyer gets something that is more fuel- efficient instead. The fuel-efficient car is a substitute for the gas-guzzler. Income elasticity is another important term. If you get a raise, how do you spend it? The answer to that question is called income elasticity. If income goes up by ten percent, and the demand for an item goes up 20 percent as a result, then you would divide the increased demand (20 percent) by the increased income (ten percent). This time the answer is two. More money means you can buy something nicer: getting the steak instead of hamburger, or choosing a dream home. This shows up in whether the income elasticity is a positive number or a negative one. If it is negative, that means getting a raise meant you stopped buying a cheaper alternative — inferior goods. If it is positive, getting a raise meant you could buy normal goods, like canned beans instead of the dry ones. All of the ratios calculated above are called elasticity coefficients, and they measure something specific and useful about the relationship between supply and demand. For example: If the coefficient for income elasticity is zero, it’s called inelastic demand. There wasn’t any increased demand, which basically means that getting a raise didn’t motivate you to go out and buy something. If the coefficient is a number between zero and one, the purchase was a necessity. If the coefficient was one or more, then the purchase was either a flat-out luxury item, or the quality was unusually good and had the price tag to match; in other words, it was a superior good. The whole concept of elasticity means people have options when it comes to buying. If you raise the price on something that isn’t a necessity, customers can choose to accept the price increase, or they can reject it. Accepting the price increase makes the demand inelastic — it didn’t change anything. The demand is elastic if customers can choose to either delay buying the item, or can choose not to make the purchase at all. Let’s show three ways this might happen.

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