1.2.3 + 1.2.4 + 1.2.5 Flashcards
price elasticity of demand (PED) measures :
responsiveness of quantity demanded for a product after a change in the good’s own price.
formula for calculating co efficient of PED
%change in quantity demanded / %change in price
PED = 0 means
perfectly inelastic – i.e. demand does not change at all when the price changes – the demand curve is drawn as vertical.
PED between 0 and -1
If PED is between 0 and -1 (% change in quantity demanded from A to B is smaller than the % change price), demand is price inelastic.
if PED = -1
If Ped = -1 (the % change in quantity demanded is exactly the same as the % change in price), demand is unit price elastic. A 15% rise in price = 15% contraction in demand
If Ped is between -1 and -∞,
demand is price elastic
If Ped = ∞
then demand is perfectly elastic – quantity demanded will fall to zero if the price rises – the demand curve will be drawn as horizontal
What are the main factors that influence the coefficient of price elasticity of demand for a product?
- Number of close substitutes
- Time available
- Degree of necessity
- % of total expenditure
- addictive ness,
price inelastic relationship with revenue
- price inelastic, a rise in price leads to a rise in total revenue – for example, 20% rise in price might cause demand to contract by only 5% (-0.25)
price elastic demand relationship with revenue
price elastic, a fall in price leads to a rise in total revenue - for example, a 10% fall in price might cause demand to expand by 25% (i.e. PED = +2.5).
price perfectly inelastic demand relationship with revenue
perfectly inelastic (PED=0), a given price change will result in the same revenue change, for example, a 5 % increase in a firm’s prices results in a 5 % increase in its total revenue since demand is unchanged.
As we move from left to right along the demand curve, PED becomes
increasingly price inelastic, this is because the % change in price increases as you go along, but the change in quantity demanded is increasing
Firms can use PED estimates to predict:
- Effect of a change in price on their total revenue. (Total revenue = price per unit x quantity sold)
- Price volatility in a market following changes in supply
- Effect of a change in an indirect tax on price and quantity demanded
what is income elasticity of demand?
Income elasticity of demand (YED) measures the relationship between a change in demand following a change in the real income of consumers.
formula for YED - income elasticity of demand
Percentage change in demand divided by the percentage change in income.
normal goods and YED
positive income elasticity of demand so as consumers’ income rises, more is demanded at each price i.e. there is an outward shift of the demand curve.
normal necessities and YED
Normal necessities have an income elasticity of demand between 0 and +1 for example, if income increases by 10% and demand for fresh fruit increases by 4%, income elasticity is +0.4. Demand is rising less than proportionately to income – demand is income inelastic.
luxury goods and services and YED
Luxury goods and services have an income elasticity of demand > +1 i.e. demand rises more than proportionate to a change in income – for example an 8% increase in income might lead to a 10% rise in demand for new kitchens. Income elasticity of demand in this example is +1.25 - demand is income elastic.
inferior goods and YED
Inferior goods have a negative income elasticity of demand meaning that demand falls as income rises
Cross-price elasticity of demand (XED) + formula
measures the responsiveness of demand for good X following a change in the price of good Y (where Y is a related good
%change of demand of product X / % change in price of product Y
Eg, unrelated good = 0
what does XED allow a distinction between?
substitute and complementary goods
substitute goods XED
positive cross price elasticity of demand. (I.e. XED > 0) which means that an increase in the price of one product will lead to a rise in demand for its substitute
complementary goods XED
When there is a strong complementary relationship, cross elasticity of demand (XED) 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.
supply definition
Supply is the quantity of a good or service that producers are willing and able to supply at a given price in a given time period.
law of supply
The law of supply is that as price rises, so businesses expand supply. This is because higher prices provide a profit incentive for firms to expand production to meet growing demand
a supply curve shows a relationship between :
market price and how much a firm is willing and able to sell
price rise/fall = ____ in supply
rise = expansion
fall in price = contraction in supply
three key reasons why supply curves are drawn as sloping up from left to right giving a positive relationship between market price and quantity supplied
- Profit motive
- Higher prices - more firms enter - more output - more supply
- Higher production = use more resources = higher costs = only if prices are rising to maintain profit margins
key factors that can cause a shift in the supply curve:
- Changes in production costs
- changes in technology
- government taxes and subsidies and regulations
- changes in climate for agricultural industries
- change in prices of substitute
- number of firms in the market
how can changes in production costs affect the supply curve?
a. Lower costs mean that a business can supply more at each price
b. rise in price of raw materials or higher wages, then businesses cannot supply as much at the same price and this will cause an inward shift of the supply curve.
c. A fall in the exchange rate causes an increase in prices of imported components and raw materials
supply shock definition + example
A supply shock occurs when an outside event has an impact on the ability of producers to supply goods and services to a market.
- flood, pandemic, tsunami
what is joint supply
Joint supply is where an increase or decrease in the supply of one good leads to an increase or decrease in supply of a by-product.
lamb and wool
What is price elasticity of supply? (PES)
Price elasticity of supply (PES) measures the relationship between change in quantity supplied and a change in price.
If supply is price elastic
producers can increase their output without a rise in cost or a time delay.
If supply is price inelastic
firms find it hard to change their production in a given time period.
Formula for price elasticity of supply
% change in quantity supplied divided by the % change in price
Values of the coefficient of price elasticity of supply
- When PES > +1, supply is price elastic.
- When PES < 1, supply is price inelastic.
- When PES = 0, supply is perfectly inelastic (and the supply curve is drawn vertically).
- When PES = infinity, supply is perfectly elastic (and the supply curve is drawn horizontally).
if it is perfectly elastic supply
horizontal
an increase in demand can be met without any change in market price
if it is perfectly inelastic supply
vertical
supply fixed and does not respond to a change in the market price
Factors that affect price elasticity of supply
- level of spare capacity - can increase to max if needed
- Stocks - can change output - elastic
- perishability - will product rot/ decay over time
- Time - less time to stockpile - can’t change output in relation to price
XED formula example
if airplane1 price 1000, and had 200 q demanded, and airplane 2 is the exact same, and airplane 1 decides to raise prices by 5% to 1050, ceteris paribus 200 will become 0 demanded and airplane 2 will have a price off 1000 and demand gone from 200-> 400, which is a 100% increase XED WILL BE 100/5 = 20%
Why is income elasticity of demand(YED) important?
- important for businesses to know how sales will be affecte by changes of income in the population
- may have an impact on which people of good a firm produces
