4. Elasticity Flashcards
Define elasticity
A measure of the sensitivity of one variable to changes in another variable
Define PED
Prince elasticity of demand : a measure of the sensitivity of quantity demanded to a change in the price of a good or service.
Percentage change in quantity demanded divided by percentage change in price
D demand
O ver
P price
E elasticity
Ped using point elasticity
Is PED x (p/qd)
At that specific point along the curve
Values of ped meanings using a diagram
Elastic
Ignoring signs
Elastic / inelastic / unit elastic
PED >1 : elastic
A percentage change in price will cause a larger percentage change in demand
The higher the ped the more elastic.
Shallow graph
Perfect elastic demand is ped plus/minus infinity. Any increase in price means demand will fall to zero
Inelastic
Ignoring signs - between 0 and 1 / <1
Percentage change in price leads to a smaller percentage change in demand
Steep curve
Perfect elasticity of 0. Meaning any change in price doesn’t effect demand
Unit elastic
Ped plus/minus 1
Change in price = change in quantity demanded
Curved l shape curve
Elasticity on a straight demand curve varies
-demand is price elastic when price is relatively high
-in this range (top half of curve) qd is sensitive to a change in price.
-as moved towards the centre total revenue rises (the increase in quantity sold more than compensates for the fall in price
- mp is unit elastic (tr stops rising)
-lower half is inelastic : increase in qd does not compensate for the fall in price.
Draw diagram
Relationship of ped and a firms total revenue
Elastic :
For a price increase, total revenue falls. For a price decrease, total revenue rises
Unit elastic : does not change when price changes
Inelastic:
For a price increase, revenue rises. for a price decrease, revenue falls
Factors which determine PED
-availability of substitutes for a good: most important. If there are no substitutes consumers have no alternative option- demand will remain regardless of price ( inelastic).
Many alternative goods allows consumers to buy else where - demand is sensitive to price (elastic)
Luxury goods tend to be elastic, necessity- inelastic
-the relative share of expenditure on the good in the consumers budget : when a significant portion of income is involved, demand is price sensitive/ elastic
-time consumers have to adjust : consumers may respond more strongly to a change in price in the long run than the short run. Demand tend to be more elastic in the long run
Taxes
Why tax
Indirect tax: levied on expenditure (are charged when the food is bought). Not specific to the buyers income.
Direct : levied in the income/profit/ wealth of people and businesses
- to raise gov expenditure
- influence public spending patterns (incentives)
- impact income equality
- reduce competitiveness of competitive goods.
Indirect tax impact on supply
Indictment taxes collected by businesses selling the good are seen as an increase to the cost of production - it reduces supply- s curve shifts INWARDS
Draw the diagram
If the good has elastic price (sensitive to demand) the tax is EFFECTIVE
However if the good is price inelastic (e.g. Cigarettes) the demand is not effected, tax is INEFFECTIVE
Subsidies
A grant given by the government to producers to encourage production of a good or service
Acts as a fall in the cost of production, supply increases (shifts outwards).
If price elastic then effective
If price inelastic not effective
YED
Income elasticity of demand.
A measure of the sensitivity of quantity demanded to a change in consumer incomes
Percentage of change in price divided by percent change in consumer income
YED values
Ignoring tha signs
YED>1 = income elastic
Shallow curve . An increase in incomes leads to a larger increase in demand
YED<1= income inelastic. Steep curve. A change in income leads to a smaller change in quantity demanded.
YED=0 . Vertical demand curve. No matter how high incomes rise demand remains constant.
Inferior goods
One where the quarry demanded decreases in response to an increase in consumer incomes
YED is negative
As incomes rise inferior food is replaced with those considered higher quality
