4: Elasticity

Question 1

What is price elasticity of demand?

Answer 1

The measure of responsiveness of the quantity demanded of a good to a change in its price (unit free)

Question 2

Formula for price elasticity of demand

Answer 2

Percentage change in quantity demanded 
/
Percentage change in price 
(Q2-Q1/Qaverage)*100%
/
(P2-P1/Paverage)*100%
Ignore any minus signs

Question 3

Describe a perfectly inelastic demand

Answer 3

Elasticity: 0
Demand curve is vertical
Quantity demanded does not change when price changes

Question 4

Describe a unit elastic demand

Answer 4

Elasticity: 1

Change in quantity demanded and change in price is the same

Question 5

When is the price elasticity of demand inelastic? elastic?

Answer 5

Inelastic: Numerator smaller than denominator; less than 1, demand doesn’t change much when price fluctuates
Elastic: Numerator bigger than denominator; greater than 1, demand changes a lot when price fluctuates

Question 6

Describe a perfectly elastic demand

Answer 6

Elasticity: Infinite

If the price changes even a little bit, demand goes to 0

Question 7

How can you change price to manipulate total revenue? (depending on the demand elasticity) 7

Answer 7

Elastic: Decrease price to increase total revenue
Inelastic: Increase price to increase total revenue
Unit elastic: Price increase or decrease doesn’t change total revenue

Question 8

Formula for income elasticity of demand

Answer 8

Percentage change in quantity demanded
/
Percentage change in income

Question 9

How can you identify normal and inferior goods with income elasticity?

Answer 9

Normal good: Income elasticity is greater than 1 (income elastic) or between 0 and 1 (income inelastic)
Inferior good: Income elasticity is less than 0 (negative)

Question 10

Formula for cross elasticity of demand (substitutes & complement)

Answer 10

Percentage change in quantity demanded 
/
Percentage change in price of substitute or complement 
Substitute: Cross elasticity is positive
Complement: Cross elasticity is negative

Question 11

What is elasticity of supply?

Answer 11

The responsiveness of the quantity supplied of a good to a change in its price

Question 12

Formula for elasticity of supply

Answer 12

Percentage change in quantity supplied
/
Percentage change in price

Question 13

When is supply perfectly inelastic? perfectly elastic? elastic?

Answer 13

Perfectly inelastic: Supply curve is vertical, elasticity: 0
Unit elastic: Supply curve is linear, passing through origin, elasticity: 1
Perfectly elastic: Supply curve is horizontal, elasticity: infinity