2.6 Elasticity Flashcards
The role of markets
What is elasticity?
A measure of the sensitivity of one variable to changes in another variable
A measurement of the extent to which buyers and sellers respond to particular change in market conditions
When would the demand curve be elastic?
When the proportional change in demand is greater than the proportional change in price
When would the demand curve be inelastic?
When the proportional change in demand is less than the proportional change in price
What is the price elasticity of demand (PED)?
The responsiveness of the quantity demanded to a change in the price of a good/service
What’s the equation for PED?
%Δ price
What will the PED always be?
Negative
When will the PED be smaller than -1?
If the %Δ in QD is larger than %Δ in price (therefore it’s elastic)
When will the PED be between 0 and -1?
If the %Δ in QD is smaller than the %Δ in price (therefore it’s inelastic)
What is total revenue?
- price x quantity sold
- The total money a firm receives from selling goods/services
What determines the PED for a particular group of products?
- Availability/closeness of substitutes (inelastic: no susbstitute, elastic: close substitute)
- If the good is a necessity or luxury (inelastic: necessity, elastic: luxury)
- Relative expense of a product with respect to income/overall expenditure (inelastic: low prop. of income, elastic: high prop. of income)
- Time period under consideration (inelastic: short time period, elastic: long time period)
What is income elasticity of demand (YED)?
How responsive quantity demanded is following a change in consumer income
What’s the equation for YED?
%Δ income
What happens if the YED is positive or negative?
If it’s positive, it’s a normal good (increase in demand when income goes up). If it’s negative, it’s an inferior good (decrease in demand when income goes up)
For YED, when is a good an elastic inferior good?
If the YED value is below -1
For YED, when is a good an inelastic inferior good?
If the YED value is between -1 and 0
For YED, when is a good an inelastic normal good?
If the YED value is between 0 and 1
For YED, when is a good an elastic normal good?
If the YED value is above 1
What factors determine the value of YED?
- Level of income
- Availability of substitutes
- Degree of necessity
What is cross elasticity of demand (XED)?
The responsiveness of quantity demanded for one good/service in relation to a change in price of some other good/service
What’s the equation for XED?
%Δ price of product B
What does a positive and negative XED suggest?
Positive suggests as substitute relationship (increase in price of B leads to an increase in demand of A)
Negative suggests a complimentary relationship (increase in price B leads to a decrease in demand of A)
What does it mean if the value of the XED is close to 0?
The products have weak complimentary
For XED, when do the two goods have a strong compliment?
When the XED value is below 0
For XED, when do the two goods have a weak compliment?
When the XED is between -1 and 0
For XED, when do the two goods have a weak substitute?
When the XED value is between 0 and 1
For XED, when do the two goods have a strong substitute?
When the XED value is above 1
What is the price elasticity of supply (PES)?
The responsiveness of the quantity supplied to a change in the market price
What’s the equation for PES?
%Δ price
What will the PES always be?
Positive
What are the factors determining the PES?
- Availability of stock of the product
- Can product be stored? (elastic: yes, inelastic: no)
- Does the insutry have spare capacity? (elastic: more space, inelastic: less space)
- Availability of factors of production (elastic: more availability, inelastic: less availability)
- Length of production process (elastic: short, inelastic: long)
- Time period (elastic: long run, inelastic: short run)
Why is PED useful to a firm?
- Can forcast the impact of a change in price on sales volume/revenue
- Allows them to know how to price their products e.g. pricing train tickets different based on times (price discrimination)
- Can focus on advertising rather than increasing/decreasing price (non-pricing policy)
What problem is there to firms when using PED?
- Cannot assume other firms won’t do the same
What’s happening to people’s real disposable income over time (YED)?
It’s increasing so people will spend more on income elastic normal goods, therefore firms with positive YED will do well in the future
What will happen to demand for income elastic products (YED)?
It will fall, therefore demand for inferior income inelastic goods will increase
For XED, what could businesses do with complimentary goods?
- Bundle them e.g. selling meal deals
- Take over businesses selling the compliments
How is XED useful for firms?
It helps anticipate changes in demand if prices of others are changing
Helps firms realise who their competition is in the market and whether their products are substitutes or complimentary.
What’s the effect of PED on the impact of an indirect tax e.g. sugar tax?
If the tax is elastic, it’s more effective. If the tax is inelastic, it’s less effective
What’s the effect of PED on the impact of a subsidy e.g. windfarm investment?
If the subsidy is elastic, it’s more effective. If the subsidy is inelastic, it’s less effective.
How would the government collect the data to measure each elasticity?
PED + YED: consumer surveys
XED: competitor analysis
PES: past company records
