Elasticities

Limitations of Elasticity Concepts

Difficulty in Computing Values:

Accurately determining elasticity values involves collating and analysing a considerable volume of market data, which is time-consuming and challenging due to market fluctuations. For instance, a firm may need to conduct surveys or use sales data to assess how much quantity demanded changes with a given price change. Even then, different data sources might give conflicting information, making it difficult to pin down a precise elasticity value. Additionally, these values rely on historical data, which may not predict future behaviour accurately, especially in rapidly changing markets such as technology or fashion.

Unrealistic Assumption:

The principle of ceteris paribus – all other things being equal – is a fundamental assumption underlying elasticity. However, in real-world scenarios, multiple factors often change concurrently, influencing demand and supply. For instance, when the price of smartphones changes, it isn't just the price affecting demand. Simultaneous changes in consumer income, preferences, or the prices of related goods (like tablets or laptops) could also impact demand. This makes it difficult to isolate the effect of one variable and can lead to inaccurate elasticity calculations.

Inability to Account for Production Constraints:

Elasticity measures can suggest that a firm should increase supply in response to price increases. However, real-world constraints can make this impossible or uneconomical. For example, a bakery may find that demand for its bread increases when a competitor closes. While the PES might suggest it can raise supply by baking more bread, it may be physically limited by oven capacity, availability of ingredients, or the number of bakers. This means the real-world supply response may be lower than the PES would suggest.

Insensitivity to Time:

Elasticity values are typically based on a specific time period and may not be applicable or accurate for different time frames. For instance, a firm's PES might be low in the short term if it's hard to quickly increase production. However, the firm could invest in new factories or machinery in the longer term, leading to a higher PES. So the same firm could have different PES values depending on the timeframe considered.

Over-Simplification of Consumer Behavior:

The application of elasticity concepts often assumes consumers respond rationally and predictably to changes in price, income, or the prices of related goods. However, consumers' choices can be influenced by a myriad of other factors. For example, consumers might be loyal to a particular brand and not change their buying habits much in response to price changes, making demand seem inelastic. Or consumer trends might suddenly make a product more popular, leading to an unexpected surge in demand despite price increases.

Each of these limitations shows the challenges of applying elasticity concepts in real-world contexts. However, it remains a valuable tool in economic analysis when used judiciously and in conjunction with other market insights and data.

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