3. Elasticities

Question 1

What is the definition of “price elasticity of demand”?

Answer 1

Measures how responsive the demand for a good is to changes of its own price

PED = % change in Qd / % change in price

Question 2

What is the “PED midpoint method” calculation?

Answer 2

Used when we need to calculate the Price Elasticity of Demand between 2 points (A & B) on the demand curve

Question 2

What is the PED when the demand is unit-elastic?

Answer 2

PED = 1,
unit-elastic demand. % change in price is the same as % change in demand.

Question 3

What is the PED when the demand is elastic?

Answer 3

PED > 1,

% change in Qd is greater than % change in P

Consumers are responsive to a change in price

Question 4

What is the PED when the demand is inelastic?

Answer 4

PED < 1,

% change in P is greater than % change in Qd.

Consumers are unresponsive to a change in price

Question 5

How does the steepness of a curve show PED?

Answer 5

The steeper the curve, the more inelastic

Question 6

How does “perfectly inelastic” demand look like?

Answer 6

–> Perfectly inelastic
–> Qd doesn’t change after a change in price
–> PED = 0

Question 7

How does “perfectly elastic” demand look like?

Answer 7

–> Perfectly elastic demand
–> Qd falls to 0 with any change in price
–> PED = infinity

Question 8

How does the PED change along a demand curve?

Answer 8

For most demand curves, the price elasticity of demand changes along the demand curve

Question 9

Impact of changes in expenditures and elasticity?

Answer 9

• 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

Question 10

What are the determinants of PED?

Answer 10

1. Availability of close substitutes
2. Whether the good is a necessity or a luxury
3. Time

Question 11

What is the “availability of close substitutes”? (Determinant of PED)

Answer 11

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

Question 12

What is the “whether the good is a necessity or a luxury”? (Determinant of PED)

Answer 12

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)

Question 13

What is the “time”? (Determinant of PED)

Answer 13

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.

Question 14

What is the “cross-price elasticity of demand” and how do you measure it?

Answer 14

Measures how responsive demand for one good is to changes in the price of some good

Question 15

What is the “Income elasticity of demand” and how do you measure it?

Answer 15

–> It measures how responsive demand for one good is to changes in consumers’ income
–> If negative = inferior good
–> If positive = normal good

Question 15

What is the “Price elasticity of supply”? (PES)

Answer 15

Measures how responsive supply of a good is to changes in that good’s price

Question 16

What are the determinants of “Price elasticity of supply”? (PES)

Answer 16

1. Availability of inputs
   –> The price elasticity of supply will tend to be greater the easier it is to obtain the requisite inputs
2. Time
   –> The price elasticity of supply will tend to increase with the period of time producers have to respond to a price change.

Question 17

What is “welfare economics”?

Answer 17

Welfare economics is the study of the change in consumers’ and producers’ wellbeing. Welfare maximization requires maximising the sum of consumers and producers’ surpluses

Question 18

What is “consumer surplus”?

Answer 18

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

Question 19

What is “producer surplus”?

Answer 19

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

Question 20

What is “total surplus”?

Answer 20

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