Price Elasticity

Price Elasticity

Note that while price elasticity is related to the slope of the line, it is not actually the slope of the line.

Recall that the slope of the line is calculated by "rise over run," or the change in the y-axis divided by the change in the x-axis.

Price elasticity is calculated by "run over rise," or the change in quantity (on the x-axis) divided by the change in price (on the y-axis).

Generally, a curve is elastic if it is flat and more inelastic if it is more verticle. However, this can be a little misleading.

Even on a linear (straight) demand or supply curve, the elasticity is not constant for the whole curve. The reason for this is that we are measuring the percentage change in both price and quantity. As you move along a linear curve and approach one of the axes, the percentage changes in that axis variable (either price or quantity) get smaller and smaller and the percentage changes of the opposite axis get bigger and bigger.

Price elasticity does NOT have a unit attached to it. That is, price elasticity is not measured in dollars or %, it is simply a ratio.

Price Elasticity of Demand

The first law of demand states that as price increases, less quantity is demanded. This is why the demand curve slopes down to the right. Because price and quantity move in opposite directions on the demand curve, the price elasticity of demand is always negative.

The image below shows the price elasticity of demand at different points along a simple linear demand curve, Q_D = 8 - P.

Difference Between Finance And Economics

Difference Between Finance And Economics

Although they are often taught and presented as very separate disciplines, economics and finance are interrelated and inform and influence each other. 

 (For background reading, see Is finance an art or a science?)

ECONOMICSWhat is it?

Without falling back on dry academic definitions, economics is a social science that studies the production, consumption and distribution of goods and services, with an aim of explaining how economies work and how their agents interact. Although labeled a "social science" and often treated as one of the liberal arts, modern economics is in fact often very quantitative and heavily math-oriented in practice.

How is economics useful?

When economists succeed in their aims to understand how consumers and producers react to changing conditions, economics can provide powerful guidance and influence to policy-making at the national level. 

Economics as a career 

For those who choose to pursue economics as a career, academia is an obvious option. Academics not only spend their time attempting to teach students the principles of economics, but also researching within the field and formulating new theories and explanations of how markets work and how their agents interact.

There is also call for economists in the corporate world. Here the concerns of economists are more immediate and near-term. Economists working for major investment banks, consultancies, and other corporations often focus on forecasting growth (GDP, for instance), interest rates, inflation, and so on. These projections may represent a product in their own right (that can be marketed to clients) or an input for managers and other decision-makers within the company. 

FINANCE What is it?

Finance in many respects is an offshoot or outgrowth of economics, and many of the notable achievements in finance (at least within academia) were made by individuals with economics backgrounds and/or positions as professors of economics. 

Finance generally focuses on the study of prices, interest rates, money flows and the financial markets. Thinking more broadly, finance seems to be most concerned with notions like the time value of money, rates of return, cost of capital, optimal financial structures and the quantification of risk.

How is finance useful? 

While economics offers the pithy explanation that the fair price of an item is the intersection of supply, demand, marginal cost and marginal utility, that is not always very useful in actual practice. People want a number, and many billions of dollars are at stake in the proper pricing of loans, deposits, annuities, insurance policies and so forth. That is where finance comes into play – in establishing the theoretical understandings and actual models that allow for the pricing of risk and valuation of future cash flows

Finance also informs business managers and investors on how to evaluate business proposals and most efficiently allocate capital. 

Basically, economics posits that capital should always be invested in a way that will produce the best risk-adjusted return; finance actually figures that process out.

Finance as a career

In some respects, a degree or academic background in finance opens more obvious doors than a similar background in economics. A degree in finance is a common denominator among many of those who populate Wall Street, be they analysts, bankers or fund managers. Likewise, many of those who work for commercial banks, insurance companies and other financial service providers have college backgrounds in finance. Apart from the finance industry itself, a degree in finance can be a pathway into and through the senior management of companies and corporations. 

In the markets

As finance tries to concern itself with assessing the value of financial instruments, it is not surprising that one of the most common applications of finance in the markets is in the determination of fair value for a wide range of investment products. Stock-pricing models like the capital asset pricing model, option models like Black-Scholes, and bond concepts like duration are all byproducts of applied finance in an investment context.

Finance also offers new theories about the "right" way to do things, whether that is the optimal dividend or debt policy for a corporation or the proper asset allocation strategy for an investor.

It can also be argued that finance affects the markets with a seemingly constant stream of new products. Although many derivatives and advanced financial products have been maligned in the wake of the Great Recession, the fact remains that many of these instruments were designed to address and solve market demands and needs.

The Bottom Line

It is important for investors to avoid "either/or" arguments regarding economics and finance; both are important, and both have valid uses and applications. In many respects, economics is "big picture" (how a country/region/market is doing) and concerned about public policy, while finance is more company/industry-specific and concerned about how companies and investors evaluate and price risk and return. Historically, economics has been more theoretical and finance more practical, but this has changed in the last 20 years.

It is interesting to note, though, that the two disciplines seem to be converging in some respects. It seems that academics in finance are trying to incorporate more and more theory into their work and appear more academically rigorous. At the same time, there is at least a movement within some schools of economics to lean more heavily on math and appear practical and applicable to everyday business and policy decision-making processes. (This decision-making tool integrates the idea that every decision has an impact on overall risk. See Multivariate Models: The Monte Carlo Analysis.)

At some fundamental level, there will always be a separation, but both are likely to remain very important to the economy and financial markets for some time to come. 

Economics complements and supplements

Economics complements and supplements

Complementary goods are those that are often used together, such as motor vehicles and gasoline or DVDs and DVD players.

Complementary Illustration

• When the price of one good declines (or increases) and the demand for a related good increases (or decreases), then the two goods are considered complementary. For example, if the price of computers increases and the demand for software declines, computers and software can be considered complementary.

• Definition of 'Complement'

  
  
  A good or service that is used in conjunction with another good or service. Usually, the complementary good has little to no value when consumed alone but, when combined with another good or service, it adds to the overall value of the offering. Also, good tends to have more value when paired with a complement than it does by itself. 

Explains 'Complement'

A product can be considered a complement when it shares a beneficial relationship with another product offering. In an economic sense, when the price of a good rises, the demand for its complement will fall because consumers don't want to use the complement alone.

For example, if the price of hot dogs rises so much that people stop consuming them, this will also cause a decrease in demand for hot dog buns. Because the price of hot dogs has an inverse relationship to the demand for hot dog buns, we call them complementary products. 

• Compliments 
  *When the price of a complimentary good (Ex:Hamburger Buns) increases, the demand for the other good (Hamburger Patties) will decrease and vice versa. 
  
  Supplements 
  *When the price of a supplementary good increases (Ex: Nike Shoes) increases, the demand for the other good (K-Swiss Shoes) will increase and vice versa.