1.6 Elasticity Flashcards
price elasticity of demand definition
the responsiveness of demand to a change in price
PED calculation
percentage change in Qd/ percentage change in price
PED is always…
negative
why is PED always negative?
it reflect the law of demand (the inverse relationship between price and quantity demanded)
price elastic demand
︱PED︱> 1
PED = big/small
relatively responsive demand
price inelastic demand
︱PED︱< 1
PED = small/big
relatively unresponsive demand
perfectly elastic demand
︱PED︱= infinity
unlimited demand at a fixed price
perfectly inelastic demand
︱PED︱ = 0
PED = 0/x
unit elastic demand
︱PED︱=1
PED = x/x
mathematical hypothetical
the steeper the demand curve
the more inelastic the demand
you can only visually compare PED if…
- the scales are the same
- the comparison is within the same two prices
why isn’t unit elasticity of demand a straight line?
even though the gradient is constant, the PED at different points is actually different
factors determining the price elasticity of demand
- necessities vs luxuries
- the proportion of income spent on good
- length of time
- number & closeness of substitutes
why does increasing the length of time make demand more elastic
as time goes on consumers have the opportunity to…
1. consider their decision
2. get information on the availability and alternatives of the good
what affects the number of substitutes for a good
how narrowly/broadly the good is defined - the narrower the definition, the greater the number of substitutes, the more elastic
total revenue calculation
price x quantity sold
relationship between total revenue and PED
elastic demand: increasing the price, TR falls
inelastic demand: increasing the price, TR increases
price elasticity of supply definition
the responsiveness of supply to a change in the price
PES calculation
percentage change in Qs / percentage change in price
price elastic supply
PES > 1
PES = big/small
price inelastic supply
PES < 1
PES = small/big
perfectly elastic supply
PES = infinity
PES = unlimited change/ no change
perfectly inelastic supply
PES = 0
PES = no change/unlimited change
factor determining PES
- mobility of factors of production
- length of time
- spare (unused) capacity of firms
- the ability to store stocks (i.e. ability to stockpile)
why can the ability to store stocks only affect PES over short periods of time?
because once stocks are released into the market, they play no role in PES
income elasticity of demand definition
the responsiveness of demand for a good to a change in income
YED calculation
percentage change in Qd / percentage change in income
YED for normal goods
YED is positive
YED = +/+ OR -/-
YED for normal goods that are necessities
0 < YED < 1
YED for normal goods that are luxuries
YED = big/small
YED > 1
YED for inferior goods
YED is negative
YED = -/+ OR +/-
in what aspects can PED help understand the impact of indirect taxes
- determining the effectiveness of preventing consumption
- the amount of per unit tax required to be effective
- determining the effectiveness of raiding tax revenue
- tax incidence
what is tax incidence?
how much of the tax burden gets passed on to consumers and how much is absorbed by producers
tax incidence when demand is inelastic
more of the tax burden is paid by consumers
tax incidence when demand is elastic
more of the tax burden is paid by the producers
in what aspects can PED help understand the impact of subsidies
- determining the effectiveness of promoting consumption
- the per unit subsidy needed to incentivize consumption
- determining the burden on government expensive
- subsidy incidence
how do subsidies work?
lower producers cost of production to effectively shift the supply curve to the right
subsidy definition
a cash payment to producers for each unit fo production
what is subsidy incidence
how much of the subsidy gets passed on to consumers and how much is kept by producers
inelastic demand on the impact of a subsidy
the subsidy will have a limited impact on the quantity sold
-> ineffective @ promoting consumption
–> larger subsidy needed to incentivise consumption
—> expensive government spending
limitations of using PED to help firms make pricing decisions
- most firms are profit maximizers, not total revenue maximizers
- it is hard to estimate the PED of a product for firms
subsidy incidence when demand is inelastic
more of the benefit goes to consumers
subsidy incidence when demand is elastic
more of the benefit goes to producers
