1.2 How markets work- Elasticity Flashcards
Elasticity is
How responsive supply and demand is to changes in price and income
Price Elastic is
When the change in demand is greater than the change in price
Price inelastic is
When the change in demand is less than the change in price
Elastic is
When the changes in price or income affect demand
Inelastic is
When the changes in price and income doesn’t affect demand
-Usually necessary goods
1.Perfectly inelastic
2.Inelastic
3.Unitary elastic
4.Elastic
5.Perfectly Elastic
- Zero
- Less than 1
- 1
- More than 1
- Infinity
Equation of PED- Price elasticity of demand
%change in quantity demand / %change in price
Equation of YED- Income elasticity of demand
%change in quantity demand / %change in income
Equation of XED- Cross Price elasticity of demand
%change in quantity demand of good A / %change in price of good B
Equation of PES- Price elasticity of supply
%change in quantity supplied / %change in price
Percentage change is
Change / original x100
What affects the price elasticity of demand (5)
- Number of substitutes
- Time- (we will find away around the product or price if it is always inelastic/ The more time the more elastic a product gets)
- Whether it is necessity or luxury
- The % of consumers income allocated to spending on the good
- The cost of switching between products
Revenue calculation
Selling price x Quantity
When a good/service is elastic should you put prices up or down
You should put prices down
Decrease price - Increase demand
When a good/service is inelastic should you put prices up or down
Put prices up
Price increases - demand increases/stays the same
Limitations of price elasticity of demand
- You can only drop your price to a certain amount otherwise you will lose profit
- Values are based on estimates
- The Info that can be used to calculate can become outdated
- The elasticity will change overtime so the calculation will only be useful in the short term
Uses of price elasticity of demand
- Helps firms to determine the optimum price to charge
- Helps firms to decide if they should increase or decrease prices
- Can only be used to calculate the impact of a change of price on sales revenue
- Helps a firm decide on non-price strategies for increasing demand
Factors affecting price elasticity of demand
- Availability of close substitutes
- Cost of switching suppliers
- Breadth of definition of product
- Degree of necessity
- Time frame when making a choice
- Brand loyalty
7.Percentage of income spent on a product
8.Habitual demand
(YED)normal luxury goods
-YED number
-What happens to the product as incomes rise
-Income elasticity of demand exceeds +1
-As incomes rise, the proportion
of a consumer’s income spent on that product will go up.
(YED)normal necessities
-YED
-What happens to the product as incomes rise
-income elasticity of demand is positive but less than 1
–As income rises, the share or proportion of their budget on these products will fall
(YED)inferior goods
-What happens to the product as incomes rise
-As income rises, demand declines and so too will the share of income spent on inferior products.
(YED)Normal goods
-What happens to the product as incomes rise
-Income rises, more is demanded at each price
i.e. there is an outward shift of the demand curve
(YED)Inferior goods
-As incomes rise, demand falls
(YED)Luxury good
-As incomes rise, demand rises
Cross elasticity of demand (XED) measures
-Responsiveness of demand for good X following a change in the price of good Y (a related good).
(XED)Substitutes:
Substitutes have a positive cross price elasticity of demand. An increase in the price of one product will lead to a rise in demand for its substitute, as consumers swap away from the more expensive good. A high value suggests both products are close substitutes.
(XED)Complements:
When there is a strong complementary relationship, cross elasticity will be negative. An increase in the price of Good T will lead to a contraction in demand for T and a fall in demand for a complement, good S.
(XED)Unrelated products:
Unrelated products have zero cross price elasticity of demand
Uses of XED
helps classify goods as complementary or substitutes
-helps determine price point
YED measures…
How responsive quantity demanded is to changes in income.
Price elasticity of supply measures
How responsive quantity supplied is to changes in price
The higher the number of PES
the more price elastic the supply is
What is price elasticity of supply affected by
-availability of producer substitutes
-TIME BASED FACTORS:
-Many substitutes = high elasticity
-Few substitutes = inelastic
-The longer it takes to make the product more inelastic supply
-The shorter it takes the more elastic
-High capacity = inelastic supply
-Low capacity = elastic supply
-If it is hard to stock then PES is inelastic
What are the uses of PES
-firms want to be able to respond quickly to changes in price and demand
-to do so they need to make their supply as elastic as possible
-they will then take measures to improve the elasticity of their supply
Limitations of PES
-values are based of estimates
-info used to calculator PES may become outdated
-other factors may shift the supply curve cancelling the QS affect
-PES ignores any cost data
-the elasticity is likely to change over time so the calculation is only useful in the short term
