3: Elasticities Flashcards
What is elasticity?
A measure of responsiveness of a variable to changes in price or any of the variable’s determinants.
What is price elasticity of demand (PED)?
A measure of the responsiveness of the quantity of a good demanded to changes in its price.
What does it mean to be price elastic/inelastic?
If there is a large responsiveness of quantity demanded, demand is referred to as price elastic. If there is a small responsiveness, demand is inelastic.
How do you calculate PED?
%∆Qd/%∆P
How can you calculate PED if you simplify the formula?
%∆Qd/%∆P = ∆Q/Qd1 * P1/∆P
Can you have a negative PED?
Yes, PED will usually be negative. We treat it as if it is positive however. This is done to avoid confusion as they are easier to compare.
Why is PED a percentage?
- It is independent of units. Using units of oranges or currencies would be unhelpful.
- A change in price is only meaningful when you consider the original price.
Can PED be negative?
Yes it is usually negative but we take the absolute value to avoid confusion.
When is demand considered to be price inelastic?
When PED < 1 but > 0.
When is demand considered to be price elastic?
When PED > 1.
When is demand considered to be unit elastic?
When PED = 1.
When is demand considered to be perfectly elastic?
When PED = ∞
%∆P = 0 and anything /0 = infinity.
When is demand considered to be perfectly inelastic?
When PED = 0.
%∆Qd = 0 and 0/anything = 0
How does PED vary on a demand curve?
On a downwards sloping, straight-line demand curve, demand is price-elastic at high prices and low quantities, and price inelastic at low prices and large quantities.
Why does PED vary on a demand curve?
A higher percentage of income is spent on the good when the price is high meaning an increase in price will lead to a larger number of people not buying it.
What is the relationship between PED and the slope?
Explain this:
PED = slope x P/Q
The slope = ∆QD/∆P
PED = %∆Qd/%∆P = ∆Q/∆P * P1/Qd1 = slope * P1/Qd1
Determinants of PED:
- Number and closeness of substitutes
- Necessities vs luxuries
- Length of time
- Proportion of income spent on the good
How is length of time a determinant of PED?
The longer the consumer has to make a purchasing decision, the more elastic the demand. For example, if the price of heating oil changes, the consumer has little time to change their habits as it requires substitute research and firm comparison. In the short term therefore demand is relatively inelastic. In the long term however the consumer has time to switch to other forms of heating, making it more elastic.
How does the steepness of the demand curve relate to elasticity?
The flatter the demand curve, the more elastic. The steeper the demand curve, the more inelastic.
What is total revenue (TR)?
The amount of money received by firms when they sell a good or service.
How do you calculate TR?
Price * Quantity demanded
When demand is elastic, how do changes in prices change revenue?
When demand is elastic an increase in price will decrease revenue and a decrease in price will increase revenue.
When demand is inelastic, how do changes in prices change revenue?
When demand is inelastic, an increase in price will increase total revenue and a decrease in price will decrease total revenue.
When demand is unit elastic, how do changes in prices change revenue?
When demand is unit elastic a change in price does not cause any change in total revenue.
When is TR at a maximum?
TR is maximised when price is at the point where demand is unit elastic.
What is profit?
Total revenue minus total costs.
What are primary commodities?
Goods arising directly from the use of natural resources. Essentially the “land” factor of production.
Explain PED in relation to primary commodities and manufactured products:
Many primary commodities have a relatively low PED (inelastic) because they are necessities and have no substitutes (such as oil). The PED of manufactured products have relatively high PED (elastic) because they usually have no substitutes.