3. Elasticities Flashcards
What is the definition of “price elasticity of demand”?
Measures how responsive the demand for a good is to changes of its own price
PED = % change in Qd / % change in price
What is the “PED midpoint method” calculation?
Used when we need to calculate the Price Elasticity of Demand between 2 points (A & B) on the demand curve
What is the PED when the demand is unit-elastic?
PED = 1,
unit-elastic demand. % change in price is the same as % change in demand.
What is the PED when the demand is elastic?
PED > 1,
% change in Qd is greater than % change in P
Consumers are responsive to a change in price
What is the PED when the demand is inelastic?
PED < 1,
% change in P is greater than % change in Qd.
Consumers are unresponsive to a change in price
How does the steepness of a curve show PED?
The steeper the curve, the more inelastic
How does “perfectly inelastic” demand look like?
–> Perfectly inelastic
–> Qd doesn’t change after a change in price
–> PED = 0
How does “perfectly elastic” demand look like?
–> Perfectly elastic demand
–> Qd falls to 0 with any change in price
–> PED = infinity
How does the PED change along a demand curve?
For most demand curves, the price elasticity of demand changes along the demand curve
Impact of changes in expenditures and elasticity?
- If demand is elastic (ped>1): % Δ in quantity > % Δ in price ➔ price rise will reduce total expenditure
- If demand is inelastic (ped<1): % Δ in quantity < % Δ in price ➔ price rise will increase total expenditure
- If demand is unit-elastic (ped=1): % Δ in quantity = % Δ in price ➔ price rise will have no effect on total expenditure
What are the determinants of PED?
- Availability of close substitutes
- Whether the good is a necessity or a luxury
- Time
What is the “availability of close substitutes”? (Determinant of PED)
Availability of close substitutes - If there are many close substitutes for a good, then consumers can easily switch away from it when its price increases. Thus, the more substitutes a good has the the price elasticity of demand will tend to be
What is the “whether the good is a necessity or a luxury”? (Determinant of PED)
Whether the good is a necessity or a luxury - The price elasticity of demand of necessities (e.g. basic food, medicines) will tend to be than that of luxuries (e.g. foreign holidays, expensive clothes)
What is the “time”? (Determinant of PED)
Time - The longer the period of time that consumers have to respond to the price change, the more time they will have to adjust to that change and to find substitutes. So, greater price elasticity as time goes on.
What is the “cross-price elasticity of demand” and how do you measure it?
Measures how responsive demand for one good is to changes in the price of some good
What is the “Income elasticity of demand” and how do you measure it?
–> It measures how responsive demand for one good is to changes in consumers’ income
–> If negative = inferior good
–> If positive = normal good
What is the “Price elasticity of supply”? (PES)
Measures how responsive supply of a good is to changes in that good’s price
What are the determinants of “Price elasticity of supply”? (PES)
- Availability of inputs
–> The price elasticity of supply will tend to be greater the easier it is to obtain the requisite inputs - Time
–> The price elasticity of supply will tend to increase with the period of time producers have to respond to a price change.
What is “welfare economics”?
Welfare economics is the study of the change in consumers’ and producers’ wellbeing. Welfare maximization requires maximising the sum of consumers and producers’ surpluses
What is “consumer surplus”?
A demand curve represents the relationship between price and quantity demanded for a particular market
Any difference between the market price and and a consumers willingness to pay is the consumer surplus
The consumer surplus will correspond to the area above the market price line and bounded by the demand curve
What is “producer surplus”?
A supply curve represents the relationship between price and quantity supplied for a particular market
Any difference between the market price and and a producer’s willingness to accept is a surplus for the producer or producer surplus
What is “total surplus”?
The sum of CS and PS is called total surplus.
–> The total surplus is a measure of the total net gain to consumers and producers and thus a measure of the economic welfare of a market: in the previous example both consumers and producers gain from trading in second-hand textbooks as they gain some utility over & above the price they pay/receive for the good
