4. Elasticities of demand and supply Flashcards
The price elasticity of demand (PED) is the percentage change in the quantity demanded divided by the corresponding percentage change in its price.
PED=(% change in quantity)/(% change in price)
Since demand curves slope down, price and quantity changes always have opposite signs. The demand elasticity is a negative number.
The demand elasticity is high if it is a large negative number. The quantity demanded is sensitive to the price. The demand elasticity is low if it is a small negative number and the quantity demanded is insensitive to the price. ‘High’ or ‘low’ refer to the size of the elasticity, ignoring the minus sign. The demand
elasticity falls when it becomes a smaller negative number and quantity demanded becomes less sensitive to the price
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Demand is elastic price elasticity is more negative than −1.
Demand is inelastic if the price elasticity lies between −1 and 0
If the demand elasticity is −1, demand is unit elastic.
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The fallacy of composition means that what is true for the individual may not be true for everyone together, and what is true for everyone together may not hold
for the individual.
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The short run is the period after prices change but before quantity adjustment can occur.
The long run is the period needed for complete adjustment to a price change. Its length depends on the type of adjustments consumers wish to make.
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The cross-price elasticity of demand for good i with respect to changes in the
price of good j is the percentage change in the quantity of good i demanded, divided by the corresponding percentage change in the price of good j.
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The budget share of a good is its price multiplied by the quantity demanded, divided by total consumer spending or income.
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The income elasticity of demand for a good is the percentage change in quantity demanded divided by the corresponding percentage change in consumer income.
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A normal good has a positive income elasticity of demand.
An inferior good has a negative income elasticity of demand.
A luxury good has an income elasticity above unity.
A necessity has an income elasticity below unity.
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The incidence of a tax describes who eventually bears the burden of that tax.
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Unless otherwise specified, the elasticity of demand refers to the own-price elasticity. It measures the sensitivity of quantity demanded to changes in the own price of a good, holding constant the prices of other goods and income. Demand elasticities are negative since demand curves slope down. In general, the demand elasticity changes as we move along a given demand curve. Along a straight-line demand curve, elasticity falls as price falls.
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Demand is elastic if the price elasticity is more negative than −1 (for example, −2). Price cuts then increase total spending on the good. Demand is inelastic if the demand elasticity lies between −1 and 0. Price cuts then reduce total spending on the good. Demand is unit-elastic if the demand elasticity is −1. Price changes
then have no effect on total spending on the good.
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The demand elasticity depends on how long customers have to adjust to a price change. In the short run, substitution possibilities may be limited. Demand
elasticities will typically rise (become more negative) with the length of time allowed for adjustment. The time required for complete adjustment varies from good to good.
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The cross-price elasticity of demand measures the sensitivity of quantity demanded of one good to changes in the price of a related good. Positive cross-price elasticities tend to imply that goods are substitutes, negative cross-price elasticities that goods are complements.
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The income elasticity of demand measures the sensitivity of quantity demanded to changes in income, holding constant the prices of all goods.
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Inferior goods have negative income elasticities of demand. Higher incomes reduce the quantity demanded and the budget share of such goods. Luxury goods have income elasticities larger than 1. Higher incomes raise the quantity demanded and the budget share of such goods
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