Monday, February 16, 2009

Economics can be easy.

One of the surprising thing I found out in my Economics class, that this is a Quantifiable Science. Quantifiable means it can be calculated. Calculated means it can be predicted if you try hard enough.

Price elasticity is a measure that relates price fluctuations to the demand of a product. Understanding that concept bring a whole new light to the understanding of economics.

Price elasticity of demand is calculated very simply you take a percent of change in price over time and divide in percent of change in quantity of demand.

A demand for product is considered inelastic if the price changes have a very small effect on the product demand. As an example of that we can use oil, gasoline, medications, cigarettes, food, water, and electricity (i.e. necessities). A demand for product is considered elastic if the price changes have a considerable demand on the product. As an example of an elastic good we can use fashionable clothing, technology, cars, and travel (i.e. luxuries).

There are several rules that can generalize elasticity in relation to prices and revenues.

  • When demand is inelastic (price elasticity is less than 1) price and revenue go in the same direction.

    Example: price of oil goes up, oil companies post a profit.

  • When demand is elastic (price elasticity is more than 1) price and revenue go in the opposite direction.

    Example: Sony dumps the price on PlayStation, revenues go up.

Elasticity however is a two edged sword.

Let's say a new farming technology allows farmers to grow twice as much wheat. With the SUPPLY increasing the price would have to go down. This is very good for consumers, but not so good for the farmers since the price has to go down. Since the elasticity of food-stuffs is pretty low, farmers actually loose money by increasing production. While this seems ridiculous that more production equals less money, it really isn't. The only thing that can increase the revenue in this instance is increase in demand proportional enough to stave off the losses.

And that's all I have to say about this today. Here is an image showing the principle of elasticity and supply increases.

It uses medications and computers. Medications are inelastic thus having steeper curves of supply and demand. Computers are elastic thus their slopes are flatter.

O stands for original
N stands for new
EP stands for Equilibrium price (where supply meets demand)

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