2.5 ELASTICITY OF DEMAND Flashcards
Elasticity of Demand
A measure of the responsiveness of the quantity demanded of a good or service to changes in one of the factors that determines it.
Price Elasticity of Demand
A measure of how much the quantity demanded of a good change when there is a change in its price.
PED FORMULA
PED = %CHANGE IN QUANTITY DEMANDED OF GOOD X/ % CHANGE IN PRICE OF GOOD X
% CHANGE FORMULA
% CHANGE = (NEW-OLD/OLD) *100
Inelastic Goods
Insensitive to changes in prices
Price Inelastic Demand
A situation where the percentage change in the quantity of a good or service is less than the percentage change in its price.
Elastic Goods
Sensitive to changes in price.
Price Elastic Goods
A situation where the percentage change in the quantity of a good or service is greater than the percentage change in its price.
General Characteristics of Inelastic Goods
- Few Close Substitutes
- High Degree of necessity
- A small portion of income
- Addictive
- Required now, rather than later (Time)
- Elasticity coefficient less than 1
General Characteristics of Elastic Goods
- Many Substitutes
- Luxury Goods
- A large portion of income
- Non-Addictive
- Plenty of time to decide, not urgent
- Elasticity coefficient greater than 1
PED
We use PED, to determine if demand for a good is elastic or inelastic.
Inelastic Goods
Looks like an “I”-vertical
Elastic Goods
Looks flatter.
PED=0
PERFECTLY INELASTIC
PED=INFINITY
PERFECTLY ELASTIC
TOTAL REVENUE TEST
Inelastic
Price - increase
TR - increase
Price - decrease
TR - decrease
Elastic
Price - increase
TR - decrease
Price - decrease
TR - increase
Unit Elastic
Price - increase/decrease
TR - no change
TAXES
Taxes on goods with INELASTIC demand, earn more revenue due to a change in price, changing Qd very little.
INCOME ELASTICITY OF DEMAND
A measure of how much the quantity demanded of a good will change in response to a change in consumers’ incomes.
YED FORMULA
YED=% CHANGE IN QUANTITY DEMANDED OF GOOD X/% CHANGE IN INCOME
YED
If the coefficient is negative (inverse relationship) then the good is inferior. If the coefficient is positive (direct relationship) then the good is normal
ENGEL CURVE
An Engel Curve is used to show the relationship between income and quantity demanded. Income is placed on the vertical axis
Quantity demanded on the horizontal axis
SECTORS OF AN ECONOMY
As an economy grows over time, the relative size of these sectors, as a percentage of total output in the economy, changes. This process is defined as Sectoral Change. Economists use YED to understand what an increase in income will do to each sector.
