Income & Supply Elasticity: Measures, Methods & Market Impact

Key Definitions & Concepts

Income Elasticity of Demand (YED)

Measures how quantity demanded of a good changes when consumer income changes, holding other factors constant.

Formula (Proportional Method): $$E_y=\frac{\%\text{ change in quantity demanded}}{\%\text{ change in income}}$$

Classification:

classDiagram
    class YED {
        +E_y > 1: Luxury/Superior Good
        +0 < E_y < 1: Normal Good
        +E_y = 0: Income-Indifferent Good
        +E_y < 0: Inferior Good
    }

Example (Nepal Context):

• Luxury Good (E_y > 1): Smartphones (e.g., iPhone sales rise 30% when income grows 10%).
• Normal Good (0 < E_y < 1): Rice (demand rises 5% for a 10% income increase).
• Inferior Good (E_y < 0): Second-hand clothes (demand falls as income rises).

Worked Example: Daraz Sales & Income Growth

Data:

Calculation (Proportional Method): $$E_y=\frac{\frac{75-50}{50}}{\frac{25,000-20,000}{20,000}}=\frac{0.5}{0.25}=2.0$$ Interpretation: Daraz’s luxury electronics (e.g., gaming laptops) have E_y = 2.0, meaning demand grows twice as fast as income.

Supply Elasticity (PES)

Measures how quantity supplied responds to price changes, indicating producer flexibility.

Formula (Percentage Method): $$E_s=\frac{\%\text{ change in quantity supplied}}{\%\text{ change in price}}$$

Types of Supply Elasticity:

pie
    title Supply Elasticity Types
    "Perfectly Elastic (E_s = ∞)" : 10
    "Relatively Elastic (E_s > 1)" : 20
    "Unit Elastic (E_s = 1)" : 15
    "Relatively Inelastic (E_s < 1)" : 30
    "Perfectly Inelastic (E_s = 0)" : 25

Real-World Examples (Nepal):

1. Ncell Tariffs (Inelastic Supply):

   • If Ncell raises data prices by 20%, supply of 4G spectrum barely changes (E_s ≈ 0.1).
   • Why? Limited spectrum licenses; government controls supply.

2. Daraz Sellers (Elastic Supply):

   • If Daraz raises seller fees by 10%, some sellers exit the platform (E_s ≈ 1.5).
   • Why? Low entry barriers; sellers can switch to competitors like Hamrobazaar.

3. NTC Electricity (Perfectly Inelastic):

   • Short-term supply of hydroelectricity cannot adjust to price hikes (E_s = 0).
   • Why? Physical constraints (dam capacity, rainfall).

Worked Example: NTC Electricity Supply

Data:

Calculation: $$E_s=\frac{\frac{1,100-1,000}{1,000}}{\frac{7-5}{5}}=\frac{0.1}{0.4}=0.25$$ Interpretation: Inelastic supply (E_s = 0.25) means NTC cannot quickly increase output even if prices rise.

Comparative Table: Income vs. Supply Elasticity

In the Real World

1. Khalti & eSewa (Income Elasticity):

   • Superior Good (E_y > 1): Digital payments (Khalti) grow faster than income as urban Nepalese adopt fintech.
   • Data: Khalti’s user base grew 40% when per-capita income rose 15% (2020–2023).

2. Nepal Rastra Bank (Monetary Policy):

   • When remittances (a normal good) rise, NRB increases liquidity to boost demand for imported goods (e.g., electronics).
   • Example: After 2022 remittance surge (+12%), NRB lowered repo rate to stimulate consumption.

3. Pathao Drivers (Supply Elasticity):

   • If Pathao raises driver commissions by 10%, some drivers switch to Uber (elastic supply, E_s ≈ 1.2).
   • Policy Impact: Pathao must keep fees stable to retain drivers during peak demand (e.g., Dashain).

Exam Tip

1. Always state the method (proportional vs. percentage) before calculations.

   • Wrong: "Elasticity is 2."
   • Right: "Using the proportional method, $E_y=2.0$."

2. Label axes clearly in diagrams:

   • Income Elasticity: X-axis = Income, Y-axis = Quantity Demanded.
   • Supply Elasticity: X-axis = Price, Y-axis = Quantity Supplied.

3. Link to Nepal’s economy:

   • Income Elasticity: Discuss remittance-driven demand (e.g., gold, smartphones).
   • Supply Elasticity: Highlight agriculture (rice, maize) vs. manufacturing (cement, textiles).

4. Common Pitfalls:

   • Sign errors: Inferior goods have negative YED (e.g., E_y = –0.5).
   • Units: Always use percentage changes (not absolute values).

Visual Summary