Elasticity Of Substitution

Elasticity Of Substitution

Elasticity of Substitution, a measurement to indicate the ease or difficulty of substitution (by consumers) between commodities or (by producers) between factors of production. The elasticity of commodity substitution is measured by dividing the proportionate change in the ratio in which two commodities are combined by the proportionate change in the ratio of their marginal utilities. A high value, indicating that large changes in the proportions combined would produce little change in relative marginal utilities, would indicate a high degree of substitutability, and conversely. The elasticity of factor substitution (sometimes referred to as technical elasticity of substitution) is measured by dividing the proportionate change in the ratio in which two factors are combined by the proportionate change in the ratio of their marginal physical productivities. Again, a high value would indicate a high degree of technical substitutability between factors, a low one poor substitutability. The measure indicates how far substitution of one factor for another (induced, say, by a lowered price of one) could advantageously proceed before being nullified by changes in the relative productivities of the two factors.

Elasticity of Supply, the concept used to measure the response of the quantity of a commodity supplied to changes in its price. More precisely, it is the proportionate change in the quantity supplied divided by the proportionate change in price. If a x per cent rise in the price of a commodity results in a 2 per cent increase in the quantity supplied, elasticity of supply is said to have a value of (plus) two.

There are five broad categories of elasticity of supply. First, perfectly elastic supply, where an infinitesimal change in price will cause an infinitely large change in the quantity supplied. Secondly, relatively elastic supply, where a change in price results in a more than proportionate change in the quantity supplied. Thirdly, unitary elasticity, where a change in price results in an equal proportionate change in the quantity supplied. Fourthly, relatively inelastic supply, where a change in price results in a less than proportionate change in the quantity supplied. Fifthly, completely inelastic supply, where a change in price results in no change in the quantity supplied.

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