1.2 How markets work - elasticity

Question 1

Give the equation for price elasticity of demand.

Answer 1

PED =
% change in quantity demanded
———————————————–
% change in price

Question 2

What does PED measure?

Answer 2

How responsive the quantity demanded is to changes in price.

Question 3

What is PED affected by?

Answer 3

-Number of substitutes
-Time ( in the short term it is hard for people to change habits)
-Necessities tend to be price inelastic
-Cost of switching between products

Question 4

What are the uses of PED?

Answer 4

-Help firms determine the optimum price to charge
-Helps firms decide whether they should increase or decrease price

Question 5

What are the limitations of PED?

Answer 5

-Values are based on estimates
-Information used to calculate it can become outdated
-The elasticity will change over time

Question 6

What are the rules of elasticity?
Perfectly inelastic =
Price elastic =
Unitary elastic =
Price inelastic =

Answer 6

Perfectly inelastic = 0
Price elastic = >1
Unitary elastic = 1
Price inelastic = <1

Question 7

Give the equation for income elasticity of demand.

Answer 7

YED =
% change in quantity demanded
———————————————–
% change in income

Question 8

What does YED measure?

Answer 8

How responsive quantity demanded is to changes in income.

Question 9

What does the sign tell you when working out YED?

Answer 9

+ Normal good
- Inferior good

Question 10

What’s a normal good?

Answer 10

A good such as crisps and t-shirts. When incomes rise the demand for these rises as well.

Question 11

What’s an inferior good?

Answer 11

Are goods that are shops own brand goods. As incomes fall demand for these rise.

Question 12

What’s a superior good?

Answer 12

These are goods that as luxuries.

Question 13

Do normal and inferior goods have a positive or negative income of elasticity?

Answer 13

Normal goods have a positive income of elasticity.
Inferior goods have a negative income of elasticity.

Question 14

What are the uses of YED?

Answer 14

-Helps firms predict the effects of changes in incomes
-Helps businesses spread risk by offering different products at different price points
-Helps businesses plan ahead

Question 15

What are the limitations of YED?

Answer 15

-Values are based on estimates
-Forecasting changes in demand is difficult
-Information to calculate YED can become outdated

Question 16

Give the rules of elasticity for these numbers.
0
>1
1
<1

Answer 16

0 = Perfectly inelastic
>1 = Price elastic
1 = Unitary elastic
<1 = Price inelastic

Question 17

Give the equation for Cross price elasticity of demand.

Answer 17

           % change in price of Y

Question 18

What does YED measure?

Answer 18

Measures how responsive quantity demanded of one good is to changes in price of another good.

Question 19

What does the sign tell you about XED?

Answer 19

+ Are substitute goods
- Are complimentary goods

Question 20

What is a substitute good?

Answer 20

Two goods that have a positive cross elasticity. E.g. an increase in the price of gas will lead to an increase in the quantity demanded of electricity.

Question 21

What are complementary goods?

Answer 21

Two goods that have a negative cross elasticity. E.g. an increase in the price of sand will lead to a decrease in the quantity demanded of cement.

Question 22

What are unrelated goods?

Answer 22

These goods have a cross elasticity of 0. These goods are completely unrelated and have little to no effect on each other.

Question 23

What are the uses of XED?

Answer 23

-Helps to classify goods as complementary or substitutes
-Helps determine pricing policy

Question 24

What are the limitations of XED?

Answer 24

-Values are based on estimates
-Forecasting changes are difficult
-Information used to calculate it can become outdated

Question 25

Give the rules of elasticity.

Answer 25

Perfectly inelastic = 0
Price elastic = >1
Unitary elastic = 1
Price inelastic = <1

Question 26

Give the equation for price elasticity of supply.

Answer 26

         % change in price

Question 27

What does PES measure?

Answer 27

How responsive quantity supplied is to changes in price.

Question 28

What is PES affected by?

Answer 28

-Availability of producer substitutes
-The shorter the time period the harder producers find it from switching from making one product to another.
-Some products take longer to make
-Some products are impossible to hold in stock e.g. electricity

Question 29

What are the uses of PES?

Answer 29

-To help firms respond quickly to changes in price and demand
-To help take measures to improve the elasticity of their supply

Question 30

What are the limitations to PES?

Answer 30

-Values are based on estimates
-Information used to calculate it can become outdated
-Other factors may shit the supply curve cancelling the QS affect