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Question 1

What is price elasticity of demand (PED)?

Answer 1

PED measures the responsiveness of quantity demanded to a change in price.

Formula: % change in qty demanded / %change in price

Question 2

Why is PED usually negative?

Answer 2

Due to the inverse relationship between price and quantity demanded. A higher price leads to lower demand.

Question 3

What is the difference between elastic and inelastic demand?

Answer 3

Elastic demand (PED > 1): Quantity demanded is highly responsive to price changes.
Inelastic demand (PED < 1): Quantity demanded is less responsive to price changes.

Question 4

What are the special cases of PED?

Answer 4

Perfectly Inelastic Demand (PED = 0): No response to price changes.
Perfectly Elastic Demand (PED = ∞): Infinite response to price changes.
Unit Elastic Demand (PED = 1): Proportional response to price changes.

Question 5

How does the number of substitutes affect PED?

Answer 5

More substitutes = higher elasticity. Consumers can easily switch to alternatives when prices change.

Question 6

state determinants of PED (5)

Answer 6

P - Proportion of income spent: Higher proportion → more elastic.
L - Luxury vs Necessity: Luxuries → more elastic; necessities → less elastic.
A - Availability of substitutes: More substitutes → more elastic.
N - Nature of the good: Addictive goods or necessities → less elastic.
T - Time period: Longer time to adjust → more elastic.

Question 7

How do necessities and luxuries affect PED?

Answer 7

Necessities: Inelastic demand (needed regardless of price).
Luxuries: Elastic demand (not essential, influenced by price).

Question 8

How does the proportion of income spent affect PED?

Answer 8

Higher proportion of income = higher elasticity

Question 9

How does time period affect PED?

Answer 9

Longer time period = higher elasticity. Consumers have more time to adjust and find alternatives.

Question 10

How does PED affect total revenue?

Answer 10

Elastic demand: Price increase → TR falls.
Inelastic demand: Price increase → TR rises.
Unit elastic demand: TR stays constant.

Question 11

How do businesses use PED in pricing decisions?

Answer 11

Answer:

If demand is inelastic → increase prices to raise TR.
If demand is elastic → decrease prices to raise TR.

Question 12

Why is PED important for government taxation?

Answer 12

Goods with inelastic demand yield higher tax revenue, as consumers cannot reduce consumption significantly.

Question 13

How does the steepness of the demand curve relate to PED?

Answer 13

Steeper curve: Inelastic demand.
Flatter curve: Elastic demand.

Question 14

Why does PED change along a straight-line demand curve?

Answer 14

At higher prices → elastic demand (large % change in Q).
At lower prices → inelastic demand (small % change in Q).

Question 15

How is PED related to indirect taxes?

Answer 15

If demand is inelastic, the tax burden falls more on consumers → higher government revenue.
If demand is elastic, the tax burden falls more on producers → lower government revenue.

Question 16

How do supply changes affect revenue for primary commodities?

Answer 16

Supply decrease: Higher prices → increased revenue (inelastic demand).
Supply increase: Lower prices → decreased revenue (inelastic demand).

Question 17

What is the relationship between PED and total revenue?

Answer 17

Elastic demand (PED > 1): Price increase → TR decreases; price decrease → TR increases.
Inelastic demand (PED < 1): Price increase → TR increases; price decrease → TR decreases.
Unit elastic demand (PED = 1): TR remains constant regardless of price changes.

Question 18

What does it mean if demand is elastic or inelastic?

Answer 18

Elastic Demand (PED > 1): Consumers are highly responsive to price changes. Producers should lower prices to increase revenue.
Inelastic Demand (PED < 1): Consumers are less responsive to price changes. Producers should raise prices to increase revenue.

Question 19

How does an indirect tax affect supply?

Answer 19

Indirect taxes shift the supply curve leftward (S1 to S2).
Firms must receive a price higher than the original by the tax amount to supply each unit.

Question 20

How does PED affect tax revenue?

Answer 20

Inelastic demand (PED < 1): Tax revenue is higher as quantity demanded falls less.
Elastic demand (PED > 1): Tax revenue is lower as quantity demanded falls significantly.

Question 21

Why do primary commodities usually have a lower PED than manufactured products?

Answer 21

Necessities: Primary commodities (e.g., food, oil) are essential for daily life, so demand doesn’t change much with price.

Few Substitutes: Most primary goods lack close substitutes, making consumers less responsive to price changes.

Proportion of Income: They often represent a small portion of consumer spending, so price changes have less impact on demand.
Short-Term Rigidity: In the short term, consumers and industries can’t easily adjust to price changes for primary goods.

Question 22

Definition of YED

Answer 22

YED measures the responsiveness of demand to changes in income:

Question 23

What do positive and negative YED values indicate?

Answer 23

Positive YED (> 0): Normal goods (demand increases with income).
Negative YED (< 0): Inferior goods (demand decreases with income).

Question 24

What does the magnitude of YED tell us?

Answer 24

YED > 1: Luxury goods (demand rises more than proportionally with income).
0 < YED < 1: Necessities (demand rises less than proportionally with income).
YED < 0: Inferior goods (demand falls as income rises).

Question 25

How is YED calculated?

Answer 25

%change in quantity demanded of a good / %change in income

Question 26

Why is YED important for businesses?

Answer 26

Helps predict demand changes based on income fluctuations.
Firms producing luxury goods benefit from rising incomes.
Firms producing inferior goods may suffer as incomes rise.

Question 27

How do supply shifts differ for inelastic and elastic demand?

Answer 27

Inelastic demand (PED < 1): Supply shift causes large price changes but small quantity changes.
Elastic demand (PED > 1): Supply shift causes small price changes but large quantity changes.

Question 28

How does YED influence demand curve shifts?

Answer 28

Normal goods: Higher income shifts demand curve rightward.
Inferior goods: Higher income shifts demand curve leftward.

Question 29

What does the sign of YED indicate about a good?

Answer 29

YED > 0 (Positive): Normal goods (demand increases as income rises).
YED < 0 (Negative): Inferior goods (demand decreases as income rises).

Question 30

How does the value of YED differentiate necessities and luxuries?

Answer 30

YED < 1: Necessities → demand increases less than proportionally with income.
YED > 1: Luxuries → demand increases more than proportionally with income.

Question 31

How do income changes shift the demand curve for goods with different YEDs?

Answer 31

YED > 0: Demand curve shifts right as income increases (e.g., new cars, electronics).
YED < 0: Demand curve shifts left as income increases (e.g., bus rides, used cars)

Question 32

What does the Engel curve show?

Answer 32

The relationship between income (vertical axis) and quantity demanded (horizontal axis).
Upward slope: Normal goods (YED > 0).
Downward slope: Inferior goods (YED < 0).

Question 33

How do we interpret the Engel curve?

Answer 33

At low incomes, goods can be luxuries (YED > 1).
At higher incomes, the same goods may become necessities (YED < 1) or inferior goods (YED < 0).

Question 34

How does YED influence the rate of industry expansion?

Answer 34

Industries producing goods with YED > 1 (e.g., restaurants, travel) expand faster as incomes rise.
Industries with YED < 1 (e.g., food, furniture) expand more slowly.

Question 35

How does YED affect industries during economic growth or recession?

Answer 35

During growth: Goods with YED > 1 benefit the most; goods with YED < 0 may see declines.
During recession: Goods with YED > 1 experience the sharpest sales declines; inferior goods (YED < 0) may see increased demand.

Question 36

How does YED affect the sectoral structure of the economy over time?

Answer 36

As income grows:
Share of primary sector (e.g., agriculture) decreases due to inelastic demand (YED < 1).
Share of manufactured goods increases (YED > 1).
Share of services sector grows fastest due to higher YED (> 1).

Question 37

How is YED calculated from the Engel curve?
Answer:

Answer 37

Slope of the Engel curve (∆Q/∆Y) determines whether a good is a luxury, necessity, or inferior

Question 38

What is price elasticity of supply (PES)? + formula

Answer 38

PES measures the responsiveness of the quantity supplied to changes in price:

%change in quantity supplied / %change in price

Question 39

3: Interpreting PES Values normal cases

Answer 39

PES < 1: Inelastic supply (quantity supplied changes less than price).
PES > 1: Elastic supply (quantity supplied changes more than price).

Question 40

interpreting PES in special cases

Answer 40

PES = 1: Unit elastic supply (equal percentage change in quantity and price).
PES = 0: Perfectly inelastic supply (quantity remains unchanged).
PES = ∞: Perfectly elastic supply (infinite response in quantity for price change).

Question 41

How are different PES values represented on a graph?

Answer 41

Inelastic supply (PES < 1): Steeper curve.
Elastic supply (PES > 1): Flatter curve.
Unit elastic supply (PES = 1): Straight line through the origin.
Perfectly inelastic supply (PES = 0): Vertical line.
Perfectly elastic supply (PES = ∞): Horizontal line.

Question 42

State determinants of PES (5)

Answer 42

L - Length of time: Longer time → more elastic.
M - Mobility of factors of production: Higher mobility → more elastic.
S - Spare (unused) capacity: More spare capacity → more elastic.
R - Rate of cost increase: Lower cost to expand output → more elastic.
A - Ability to store stocks: Greater ability to store → more elastic.

Question 43

How does the length of time affect PES?

Answer 43

Short term: PES is inelastic as firms cannot quickly adjust production.
Long term: PES becomes more elastic as firms adjust inputs and expand capacity.

Question 44

What is the role of factor mobility in PES?

Answer 44

High mobility of factors (e.g., labor and resources) increases PES, as firms can quickly shift production.

Question 45

How does spare capacity affect PES?

Answer 45

High spare capacity: PES is more elastic as firms can easily increase production without additional costs.
Low spare capacity: PES is inelastic as production cannot expand easily.

Question 46

How does the ability to store stocks impact PES?

Answer 46

High storage capacity: PES is more elastic since firms can meet demand changes with existing inventory.
No storage capacity: PES is inelastic as firms rely solely on current production.

Question 47

How does the rate of cost increase affect PES?

Answer 47

High cost of expanding output: PES is inelastic.
Low cost of expanding output: PES is elastic as firms can adjust production without significant expense.

Question 48

Why do primary commodities have a lower PES than manufactured goods?

(5)

Answer 48

Primary commodities require time and natural processes to increase output (e.g., farming cycles).
Time is needed for agricultural products to respond to price changes.
Limited land available for cultivation; agricultural adjustment is slow.
Environmental issues and lack of advanced irrigation systems add to supply rigidity.

Manufactured goods can adjust production more quickly due to greater flexibility.

Question 49

Why is PES important for firms?

Answer 49

Helps firms predict how supply responds to price changes.
Industries with inelastic PES may struggle to increase output during price rises.

Question 50

onsequences of Low PES for Primary Commodities

Answer 50

Low PES causes price volatility, as supply cannot adjust quickly.
Price fluctuations can cause revenue instability for producers.
Farmers’ incomes are more unstable due to inelastic supply.

Question 51

Short term / Long term PES

Answer 51

Agricultural commodities have lower short-term PES compared to manufactured goods.
Long-term PES is higher as time allows for adjustments (e.g., cucumbers: 0.29 → 2.20).