4) Elasticity - MMT Flashcards
what is elasticity?
elasticity measures the responsiveness of quantity demanded for products to changes in:
- Price
- Income
- Price of other goods
as well as responsiveness of supply to changes in price
when is elasticity measured? (in quantity demanded and supply)
quantity demanded:
1) Price
2) Income
3) Price of other goods
when are goods described as “elastic” or “inelastic”?
- Highly responsive goods are -> elastic
- Unresponsive goods are -> inelastic
what 4 types of elasticity are there?
1) Price Elasticity of Demand (PeD)
2) Price Elasticity of Supply (PeS)
3) Cross Elasticity of Demand (XeD)
4) Income Elasticity of Demand (YeD)
what is the shorthand for Price Elasticity of Demand?
PeD
what is the shorthand for Price Elasticity of Supply?
PeS
what is the shorthand for Cross Elasticity of Demand?
XeD
what is the shorthand for Income Elasticity of Demand?
YeD
what variable is Elasticity?
“it depends variable” in a evaluate type question, it measures by how much will something change as a result of a change in a related factor
Elasticity = … = …
Elasticity = Responsiveness = Sensitivity
- how sensitive is the demand or supply of the product to changes in circumstances
what does “highly responsive goods” and “unresponsive/ insensitive” mean (linking to elasticity)
1) if it’s quantity changes a lot after a change in circumstances
2) if it doesn’t change by much
what is Price Elasticity of Demand (PeD)?
measures the responsiveness of quantity demanded to changes in the price of the product
Price Elasticity of Demand - what does it mean that a product is “price elasticity” or “price inelastic”?
eg if the quantity demanded changes proportionately more than the change in price (eg 10% fall in quantity after a 2% change in price), the product is price elastic
if the quantity demanded changes by proportionately less than the change in price, the product is price inelastic
what is Price Elasticity of Supply (PeS)?
it measures the responsiveness of quantity supplied to changes in the price of the product
Price Elasticity of Supply - what does it mean “supply of the product is price elastic/ inelastic”
- if the quantity supplied changes proportionately more than the change in price (e.g. 10% increase in quantity after a 2% change in price) supply of the product is price elastic
- if the quantity supplied changes by proportionately less than the change in price, the product is price inelastic
what is Income Elasticity of Demand (YeD)?
measures the responsiveness of quantity demanded to changes in the levels of RDI in the economy
Income Elasticity of Demand - what does it mean “ the product is income elastic/ inelastic”
- if the quantity demanded changes proportionately more than the change in RDI (e.g 10% fall in quantity after a 2% change in price) the product is income elastic
- if the quantity demanded changes by proportionately less than the change in income, the product is income inelastic
what is Cross Elasticity of Demand (XeD)?
measures the responsiveness of quantity demanded to changes in the price of another product
Cross Elasticity of Demand (XeD) - what does it mean “the product is cross elastic/ inelastic”
- if the quantity demanded changes proportionately more than the change in price of the other product the product is cross elastic.
- if the quantity demanded changes by proportionately less than the change in price of the other product, the product is cross inelastic
what is the equation used to calculate PeD?
percentage change in quantity demanded/ percentage change in price
when using the equation to calculate PeD, what does an answer higher than 1 or lower than 1 mean?
- higher than 1 its elastic
- lower than 1 its inelastic
!! it doesn’t matter whether its positive or negative, its the size of the number that matters!!
when using the equation to calculate PeD, is the answer a percentage or a number?
its not a percentage, if you divide a % by a % the answer is not a %
when using the equation to calculate PeD, why is it negative?
because the movement in the top and bottom lines is almost always either +/- or -/+. That’s because of the law of demand (P goes up Qd goes down)
how do you calculate YED?
% change in quantity demanded/ % change in RDI (Y)
if YED = 5, demand for this product is… elastic
highly income
if YED = 0.25, demand for this product is…
inelastic
is expected answer for YED positive or negative?
positive, if incomes rise then demand for products should too
if YED is negative, why is this significant?
it signifies an inferior good
if the sign for YED is positive what sort of goods/services are they?
normal goods or services
why do inferior gods produce a negative YED?
when RDI increases their sales might fall, when RDI decreases their sales increase, (eg Poundland does better in recessions)
what does a high YED (eg 5) show?
that the product or service is highly sensitive to changes in RDI (many luxury products fall into this caategory)
what does a low YED reveal (eg 0.2)?
consumers may continue to buy this product regardless of changes in income (milk is one examples of this, these goods are considered necessities)
summary: why is YED important?
informs businesses how their sales are likely to react to a change in RDI, most goods will increase/decrease in line with RDI, however inferior goods move i the opposite direction to RDI
what is the equation for Cross Elasticity of Demand? (XeD)
% change in the QD of good A / % change in the price of good B
what is the equation for PeS?
% change in Qs / % change in P
what sort of answer do we expect with PeS, positive or negative and why?
- positive, because in normal circumstances, any change in P will move S in the same direction
- so if P goes up Qs goes up (++)
- if P goes down Qs goes down (- -)
what makes elasticity more than 1?
- if the top line is a higher number, then the answer is more than 1 (and is elastic)
- (if the top line is a smaller number the answer is less than 1, inelastic)
in the short term what is PeS like?
many products have very low results, supply can be highly inelastic
in the long term what is PeS like?
PeS should almost always increase as businesses have time to adjust their processes to the new price
why is it important to be elastic with PeS?
a higher PES means that the business can react quickly to take advantage of higher prices (more profitable) or reduce quantities of lower price products (less profitable)
for XeD why are the signs important (+ -)?
it depends on the relationship on the goods, if they are substitutes or complementary
in XeD, are substitutes positive or negative outcome?
positive
why are the outcome of substitutes positive?
- if the goods are substitutes, an increase in price for good A, might increase Qs for B (++)
- a decrease in price for A might decrease Qd for B (- -)
in XeD what sort of goods have a negative outcome?
indicates goods in joint demand, complementary goods
why do complementary goods have a negative outcome?
- eg as the price of milk increases we may consume less tea
- therefore the top line and the bottom lines will have different signs (+ -)
what does it mean if the answer for XeD is higher than 1?
eg +2 or -2, this shows a strong link between the goods
what does it mean if the outcome for XED has a low score?
eg +0.1, or -0.2
shows that there is a weak link between the price of one good and the quantity demanded for the other
what does PeD inform for businesses?
most likely outcomes from changing the prices of their products
what does YED inform businesses?
the likely impact from changes in the economic cycle, eg recessions
what does XeD inform businesses?
the likely impact from prices changes made by other companies
what does PeS inform businesses?
informs them of the actions that are needed with production planning and schedules to ensure efficient response to changing market conditions
do businesses prefer a low or high PeD?
do businesses prefer a low or high PeS?
- low PeD
- high PeS
what do businesses prefer in terms of YeD and XeD?
they will want to have different products which will have different values, enabling them to cope in different situations
