Markets bring buyers and seller together. Buyers act in a way to meet their needs; suppliers undertake economic activities to meet such needs.
a) What do you understand by the term elasticity of demand? Identify three factors that influence consumers when deciding which goods and services and how many units of every one good/service they are prepared to buy.
b) Explain the usefulness of the concept of elasticity of supply in the short and long run.
c) Illustrate the significance for public policy formation of the above two concepts in the sector of social work or education in the Maltese islands.
In very basic and simple economic terms elasticity of demand refers to how a change in price or income affects the quantity demanded of a product or service. In other words, when the price of a product or service changes, or the income of the consumer changes, how much more or less is the consumer willing to buy? This change is measured in terms of percentages: the percentage change in the quantity demanded of the commodity as compared to the percentage change in price of the same commodity, or the percentage change in income.
Demand for a product can on one hand can be very inelastic, which would mean that the consumer would be willing to pay pretty much any price for a product. An example of this could a basic good such as water or bread. On the other hand demand for a product can be very elastic, which would mean that the consumer would be willing to pay only a certain price. An example of this could be Coke, because this type of soft drink has numerous amounts of substitutes (for example Pepsi, Dr. Pepper) from which people can choose from. A good is considered perfectly elastic when no matter how small the price change, demand will drop to zero. On the other hand a good is considered perfectly inelastic when no price change would affect the demand.
In both price elasticity of demand and income elasticity of demand, a good is considered elastic if the percent change in quantity demanded is greater than the percent change in price, which would mean that revenue for the producer falls. On the other hand a product is considered inelastic if the percent change in quantity demanded is smaller than the percent change in price, which means revenue for the producer will increase. It is considered unit elastic if the percent change in demand is exactly the same as in the price.
Other than price and income elasticity, theres also the concept of cross elasticity. This refers to the responsiveness of the demand of a good to a change in the price of another good. Again this is measured by looking at the percentage change in demand of one good as a result of the percentage change in price of another good. Products and services can either be compliments or substitutes. The former refers to commodities that are used with each other (for example bread and butter); in this case when the price of one product rises, the demand of the other product will decrease. On the other hand substitutes are products that can replace each other (for example Pepsi and Coke); in this case when the price of one increases, the demand for the other increases.
Therefore three factors that influence consumers are price, income, and the price of other goods.
Elasticity of supply refers to the measure of a change in the quantity supplied of a product as a result of a change in price of the same product. Whereas in demand quantity demanded increases as a result of a price decrease, the opposite is the case with supply. This means that the value of elasticity of supply is positive: as price rises, the quantity supplied rises, and vice-versa.
Generally, in the short run the supply is more inelastic than in the long run, because the longer time the company has to adjust its production, the more it can change its output. If a time period is extremely short, supply can also be fixed, which means that the supply of a particular good cannot respond at all to a change in demand.
To put it very simply, in the short run, by definition, there is not enough time for the producers to react to a change and thereby there is less time to change the output significantly. For instance, if a factory uses certain machinery that require fuel to be run, and the price of fuel rises, the producers still need to use these machines in the short run. There isnt time to invest in new machinery; this can only done in the long-run. In the long-run, the producer can invest in new machinery which perhaps utilize less fuel or which run on a different kind of energy source, and as a result production costs will go down and output can increase. Therefore Elasticity of Supply becomes more inelastic.
In the long-run, where no important resource is fixed, the elasticity of supply will be very high. In the long-run, more workers can be hired, more machinery can be bought, more land, and so on, and this means that supply will change. On the other hand, in the short-run, when most resources are fixed, little can be changed.
The concepts of elasticity of demand and elasticity of supply are very significant when it comes to public policy formation. If we had to look at the education system in Malta, particular tertiary education, we can see how government policies have changed the demand of education. For instance, students are given stipends and smart cards in an effort to discourage students from starting work after secondary school and instead encouraging them to continue their studies. Therefore the stipends and smart cards serve as a sort of income for the students, and as the concept of Income Elasticity of Demand stipulates, the demand for education is meant to increase.
In relation to the concept of Price Elasticity of Demand, the price of education is zero (although we still pay as taxpayers). As the concept of price elasticity stipulates, the lower the price of a product, the higher the demand for the same product. Therefore since the price of the university has always been zero, the demand cannot suddenly change. It is for this reason that the government chose to introduce a stipend system to encourage students to continue with their studies, following the theory that a rise in income will cause the demand cure to shift outwards.
In Malta therefore, the government seems to believe that demand for education is relatively (rather than highly) elastic, otherwise it would not make any sense to spend millions of euros every year to encourage students to go to university if demand for tertiary education were inelastic. Tertiary education can also not be considered highly inelastic because that would mean that a small change in price or income would lead to a sharp change in demand; this is clearly not the case as evidenced by the stipend cuts that were made a few years ago.
It could be said, therefore, that tertiary education in Malta is not quite considered a necessity. Products and services that are necessities are always very insensitive to price change, which means that consumers would still buy the product despite an increase in price or a reduction in income. In a way we could say that many Maltese might see the opportunity cost of tertiary education as very high. Despite being free of charge, many people prefer going to work once out of secondary school rather than waste time studying, with the reasoning being that three or four years at the university would be a loss of three or four years worth of salaries. Therefore in a way working in general can be considered a substitute to tertiary education, even though it is not technically so. This is undoubtedly one of the reasons why the government introduced grants for students.
When the stipends and smart cards were introduced, the cost of supply also obviously increased. Not only did the cost of supply necessarily increase because of the stipends, but since the number of university students increased, more facilities had to be built to cater for the influx of new students. The concept of Elasticity of Supply stipulates that in the short-run, the output cannot change by much and as a result the supply is generally inelastic. This applies to education in Malta. In the short-run, stipends were introduced, but this meant the money had to come from somewhere (from our taxes), and this could be done in the short-run. However, in order to cater for the increase in the student population, new facilities had to be built, and this could only be done in the long-run.
Therefore it is clear that both the concepts of elasticity of demand as well as the concept of elasticity of supply are very relevant and useful when it comes to the formation of public policy formation in the sector of education.
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