Saturday, 4 February 2017

Economics for Beginners - My Kindle Book is available now

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Wednesday, 16 November 2016

Elasticity of demand- Price elasticity and Arc elasticity methods

Meaning and Definition of Elasticity of Demand

The term 'elasticity of demand' refers to the responsiveness of demand to changes in the price of a given commodity assuming that all other factors are remaining the same.

To be more specific, the Price Elasticity or Elasticity of Demand is a measure or tool employed in finding out the percentage change in quantity demanded of a good or service in response to a one percent change in the price of that good or service.

We are all aware that whenever the price of a commodity gets increased, we tend to curtail our demand for that commodity. So, the tool of the elasticity of demand tries to measure the quantum of those changes in demand with reference to the changes in prices of that commodity.

The Elasticity of Demand is also known as the price elasticity of demand.

These terms are expressed in abbreviated terms either as Ed or PED respectively.

The elasticity of demand is mostly negative in almost all cases except in cases of status goods (Veblen goods) or goods that have no substitutes (Giffen goods).

How to measure Elasticity of Demand?

The Elasticity of Demand is measured with the help of formulas just like Elasticity of Supply.
The general equation for Price Elasticity of Demand is expressed as follows:

Price Elasticity of Demand = Percentage change in quantity demanded divided by Percentage change in Price
ie. Ed = (dQ/Q)/ (dP/P)
In the above equation, Ed denotes elasticity of demand (price elasticity).
DQ refers to the changed quantity and Q refers to the original quantity demanded.
DP refers to changed price and P refers to the original price.
You can express the above equation as (Qd1/Qd) / (P1/P) where Qd1 denotes changed quantity and Qd original quantity. P1 is new price and P is original price.
But, we know that the demanded quantity decreases whenever the price increases and the demanded quantity increases whenever the price falls. So, there is always an inverse ratio in the equation excepting in the cases as mentioned above. Hence, the equation always gives a negative value.

Two more precise result yielding formulas are being used by economists nowadays to measure the elasticity of demand. These formulas are mentioned below.

1) The Arc Elasticity of Demand formula
This method is used when there is no exact equation for demand available or when we are not accustomed to taking derivatives.
2) The Point-Price (or Price-Point) Elasticity of Demand formula
This method is used when we have the exact equation with us or when we are capable of calculating the derivatives of equations.

Now, let us study these two methods of calculation.

Arc Elasticity of Demand method
The arc elasticity method gives us the average elasticity of demand between the two end points of an arc on a demand curve. So, it gives us the average elasticity of demand for that curve. It solves the problem faced by analysts in choosing one point as the original point and the other point as the new point and thus provides a great relief from the dilemma faced by the economists in calculating the elasticity. But, it may not provide the accurate figures as you are taking the average of two points on a curve.
The mathematical equation for arc elasticity of demand is as follows:

{(P1+P2)/2} / {(Qd1+Qd2)/2} x (change in quantity demanded/change in price)

So, Elasticity of Demand according to this formula = (the sum total of prices divided by the sum total of quantities demanded at each price) x (change in quantity divided by change in price)
You are taking the average of different prices on an arc and dividing it with the average of new quantities demanded by consumers at those changed prices. Then, you are multiplying the same by the derivative of change in quantity divided by the change in price at any point to decide the elasticity at that point.

Suppose, there are two price levels for a commodity Sugarat Rs.40 per kg and Rs.50 per kg.
Let us assume that at price 40, quantity demanded is 10kg and at price 50, quantity demanded is 8kg.
Now, according to above formula, Ed = {(40 + 50) divided by (10 + 8)} x {(10 - 8) divided by (40 - 50)} = (90/18) x (-2/10) = 5 x (-1/5) = -1 or 1%
ie. Demand changed by 1% per each percentage change in the price.

1% change in original price is 40 x 1/100 = 0.40 = 40 paise.
So for every 40 paise, it is assumed that the quantity changes by 1% according to this formula.

Point-price Elasticity of Demand method
Point-price method is used to determine the elasticity of demand at very small changes in prices. It is useful in determining the price elasticity of demand at a specific point on the demand curve. It studies the changes in demands at price-points very closer to each other on a demand curve.

It also uses the same formula of the percentage change in demand divided by the percentage change in price. But, instead of calculating each equation, we can take information from the demand equation to calculate the price elasticity of demand.

Ed = percentage change in demand / percentage change in price = (Qd1/Qd) / (P1/P) = (P/Qd) x (Qd1/P1)
Now, as I mentioned above, this method is applied when we have the exact equation for demand curve and the derivatives per unit of price cahnge.

Let us take an example.
The equation for elasticity of demand for a demand curve Q = 5000 - 50P
So, in this equation, Qd1/P1 = -50 (per one unit of price, the change in demand quantity is 50).
Now, suppose we have to find out the point-price elasticity of demand at a price of 40 and 25.
The quantity demanded at 40 will be 5000-2000=3000.
The quantity demanded at 25 will be 5000-1250=3750.

So, Ed at 40 is -50 (40/3000) = -2000/3000= -2/3= -0.666
Ed at 25 is -50 (25/3750) = -1250/3750= -1/3= -0.333

Wednesday, 5 October 2016

Put a Harness on your Wants and Desires - Save Resources for your Future Generations

Satisfaction of our wants leads to consumption of goods and services. Goods are available only when you produce them. Production and manufacture of goods involve consumption of raw materials and natural resources. So, your satisfaction of desires and wants leads to the erosion of resources. There is so much of consumption and production that is indulged in by people nowadays that more and more stocks of raw materials and resources are required to satisfy these activities.

You must be aware that resources are not unlimited nor abundant at any given period or place. The resources available are much limited in number or quantity to satiate every need of the enormous population of this present day world. And, the population is always growing at a rapid rate whereas resources are getting exhausted day-by-day.

So, the need arises for finding some solution to the everlasting exhaustion of resources. Controlling our consumption levels is the most appropriate approach that can keep the resources available to mankind for a longer duration. Other options like finding new horizons of the universe for bringing more resources to the availability of people, or tracing the un-trekked lands of this world to find more resources are not feasible.

Distinguish between Necessities, Comforts, and Luxuries
One should try to bifurcate all his wants or desires into necessities, comforts, and luxuries.

Necessities are those without which you can't lead your life. You need a home or shelter. You need food. You need clothes to wear. These are necessities. You can't live without them even for some period.

Comforts are those which give some relief and aid you in leading your life smoothly. A dining table, mixie/grinder, motorcycle, computer, TV, etc. are examples for comforts which aid to your daily life. But, you can live even without them.

Luxuries are lavish expenses. A posh bungalow, a deluxe car, large LCD tv, expensive furniture, expensive clothes, beauty parlour visits are all examples of luxurious spending.

So, one should try to locate his own necessities and mostly stick to them along with some of those comforts and avoid indulging in luxurious spending.

Look at the realities around you
If you are sensitive enough to take a look into the real world around you, you will realise the seriousness of the problem.

There are so many poor and helpless around you that live in wretched conditions. They lack even the dire necessities of life whereas we live in posh bungalows and eat lavishly expensive food, wearing costly dresses and moving in luxurious cars. They don't have food to eat even for a single time in the day, wear dirty torn or worn out clothes thrown by us and walk and work for hours to get a single loaf of bread, dwelling on pavements.

This is because of the neglect of such people by the society. Instead of contributing to the welfare and development of such sections of the community we are indulging in satiating our desires. We never think of their desires or dreams. They are also human beings like us and have the same desires and dreams as we have. But, we do not like to realise this fact and reality. We simply ignore them to die their death.

If only we can put a harness on our wants and save some resources, the same could be spent for their well-being as well as for our future generations to come. These helpless people can be provided with some jobs and some welfare schemes so that they could fulfil some of their dire necessities.

Curtail your Spending Habits and Contribute to the Growth of Economy

What to do?

  1. Save Water. Be conscious about the unnecessary wastage of water. You can fix water saving nozzles to your taps to minimize the flow of water resulting in lesser consumption. Shower baths are good for saving water. While using flush outs in the toilet also you can save water by flushing only the required quantity of water instead of emptying the tank.
  2. Save Energy. Electricity consumption also needs to be saved as there is much shortage of production in this sector. Switch off the lights and fans whenever it is not necessary. Develop the habit of switching off before leaving the room into another room for more than one or two minutes. ACs and TVs should also be used only when there are people there. Whenever there is daylight available don't use lights. Fans and coolers are also not necessary when there is no heat.
  3. Save Fuel. While cooking, use the pressure cookers as far as possible to cook any kind of food. Only, topping and spicing can be done in other bowls or pans. This practice saves a lot of fuel. Further, keep everything ready before lighting the stoves or burners.
  4. Each month, try to keep some portion of your earnings for saving and investment. In this way, you can curtail your spending habits. Your savings are the seeds for the growth of the economy. Remember this fact always. Even if you can save 1% of your income, it makes a lot to the economy.
  5. You can also indulge yourself in acts of charity contributions and donations to welfare funds that work for the social wellbeing of people around you. There are so many helpless people all around you with no sufficient food, education, medical facilities. So, your donations to such organisations can reach for the rescue of these poor classes of the society.