4.1-4.2: Price elasticity of demand & more elasticities of demand

Question 1

Responsiveness of the quantity demanded of a good to a change in its price = what?

Answer 1

Slope of the demand curve:

Steep = the quantity demanded of the good isn’t very responsive to a change in the price

Flat = the quantity demanded is very responsive to a change in the price

Question 2

Define Price elasticity of demand

Answer 2

A units-free measure of the responsiveness of the quantity demanded of a good to a change in its price when all other influences on buying plans

Question 3

Define elasticity

Answer 3

the ratio of two percentage changes, so when we divide one percentage change by another, the 100s cancel.

-Measures the responsiveness of an effect to a change in some cause
-Measures the size of effect resulting from a cause

Question 4

What is a percentage change?

Answer 4

A percentage change = a proportionate change multiplied by 100.

Question 5

Why is elasticity a units-free measure?

Answer 5

Elasticity is a units-free measure because the percentage change in each variable is independent of the units in which it is measured. So the ratio of the two percentages is a number without units.

-Allows you to compare with other values

Question 6

Is price elasticity of demand a positive or negative number?

Answer 6

When the price of a good rises, the quantity demanded decreases. Because a positive change in price brings a negative change in the quantity demanded, the price elasticity of demand is a negative number (inverse relationship).

But it is the magnitude, or absolute value, of the price elasticity of demand that tells us how responsive the quantity demanded is. So to compare price elasticities of demand, we use the magnitude of the elasticity and ignore the minus sign.

Question 7

What does it mean if price elasticity of demand is 0?

Answer 7

If the quantity demanded remains constant when the price changes, then the price elasticity of demand is zero and the good is said to have a perfectly inelastic demand.

Question 8

What does it mean if percentage change in Qd = percentage change in price?

Answer 8

If the percentage change in the quantity demanded equals the percentage change in the price, then the price elasticity of demand equals 1 and the good is said to have a unit elastic demand.

Question 9

What does it mean if price elasticity of demand is infinite?

Answer 9

If the quantity demanded changes by an infinitely large percentage in response to a tiny price change,

Eg. An example of a good that has a very high elasticity of demand (almost infinite) is a soft drink from two campus machines located side by side, but one offers 1 cent cheaper

Question 10

When are goods elastic?

Answer 10

Between unit elastic demand and perfectly elastic demand is another general case in which the percentage change in the quantity demanded exceeds the percentage change in price. In this case, the price elasticity of demand is greater than 1 and the good is said to have an elastic demand.

Question 11

When are goods inelastic?

Answer 11

Between perfectly inelastic demand and unit elastic demand is a general case in which the percentage change in the quantity demanded is less than the percentage change in the price. In this case, the price elasticity of demand is between zero and 1 and the good is said to have an inelastic demand.

Question 12

The elasticity of demand for a good depends on:

Answer 12

The closeness of substitutes

The proportion of income spent on the good

The time elapsed since the price change

Question 13

How does Closeness of Substitutes
affect elasticity of demand?

Answer 13

The closer the substitutes for a good, the more elastic is the demand for it.

For example, a smartphone has no close substitutes, but an Apple iPhone is a close substitute for a Samsung Galaxy. So the elasticity of demand for smartphones is less than the elasticity of demand for an iPhone or a Galaxy.

Question 14

Define necessities

Answer 14

Necessities = goods like food and housing; need for living

A necessity has poor substitutes, so it generally has an inelastic demand.

Question 15

Define luxuries

Answer 15

Luxuries = goods like exotic vacations; can choose to live without (optional)

A luxury usually has many substitutes, one of which is not buying it. So a luxury generally has an elastic demand.

Question 16

How does Proportion of Income Spent on the Good affect elasticity of demand?

Answer 16

Other things remaining the same, the greater the proportion of income spent on a good, the more elastic (or less inelastic) is the demand for it.

**You will look for alternatives if the price change and good/service makes up a bigger percentage of your income

Question 17

How does Time Elapsed Since Price Change affect elasticity of demand?

Answer 17

The longer the time that has elapsed since a price change, the more elastic is demand.

**More inventions and substitutes are made (other alternatives)

Question 18

Elasticity of demand is the same as slope. True or false?

Answer 18

FALSE

Question 19

Explain varying elasticities on a linear demand curve.

Answer 19

That is, at the midpoint of a linear demand curve, the price elasticity of demand is 1.

At prices above the midpoint, the price elasticity of demand is greater than 1: Demand is elastic.

At prices below the midpoint, the price elasticity of demand is less than 1: Demand is inelastic.

Question 20

How does the change in total revenue depends on the elasticity of demand?

Answer 20

If demand is elastic, a 1 percent price cut increases the quantity sold by more than 1 percent and total revenue increases. (ΔP < ΔQ; TR increase)

If demand is inelastic, a 1 percent price cut increases the quantity sold by less than 1 percent and total revenue decreases. (ΔP > ΔQ; TR decrease)

If demand is unit elastic, a 1 percent price cut increases the quantity sold by 1 percent and total revenue does not change. (ΔP = ΔQ; TR same)

Question 21

Which elasticity is total revenue at a maximum?

Answer 21

At unit elasticity

Question 22

What is the total revenue test?

Answer 22

The total revenue test is a method of estimating the price elasticity of demand by observing the change in total revenue that results from a change in the price, when all other influences on the quantity sold remain the same.

-If a price cut increases total revenue, demand is elastic.
-If a price cut decreases total revenue, demand is inelastic.
-If a price cut leaves total revenue unchanged, demand is unit elastic.

Question 23

Define income elasticity of demand

Answer 23

The income elasticity of demand is a measure of the responsiveness of the demand for a good or service to a change in income, other things remaining the same. It tells us by how much a demand curve shifts at a given price.

Question 24

Only the absolute value matters for income elasticities. True or false?

Answer 24

Income elasticities of demand can be positive or negative

Question 25

What are the three ranges of income elasticity?

Answer 25

Positive and greater than 1 (normal good, income elastic)
>The percentage increase in the quantity of pizza demanded exceeds the percentage increase in income.
>The percentage of income spent on that good increases as income increases

Positive and less than 1 (normal good, income inelastic)
>The percentage increase in the quantity demanded is positive but less than the percentage increase in income.
>The percentage of income spent on that good decreases as income increases

Negative (inferior good)
>The quantity demanded of an inferior good and the amount spent on it decrease when income increases.
>Low-income consumers buy these goods and spend a large percentage of their incomes on them.

Question 26

What is cross elasticity of demand?

Answer 26

Cross elasticity of demand is a measure of the responsiveness of the demand for a good to a change in the price of a substitute or complement, other things remaining the same.

Question 27

If the cross elasticity of demand is positive…

Answer 27

demand and the price of the other good change in the same direction, so the two goods are substitutes.

Question 28

If the cross elasticity of demand is negative…

Answer 28

demand and the price of the other good change in opposite directions, so the two goods are complements.

Question 29

How does the magnitude of the cross elasticity of demand determine how far the demand curve shifts?

Answer 29

The larger the cross elasticity (absolute value), the greater is the change in demand and the larger is the shift in the demand curve.

If two items are close substitutes, such as two brands of spring water, the cross elasticity is large. If two items are close complements, such as movies and popcorn, the cross elasticity is large.

If two items are somewhat unrelated to each other, such as newspapers and orange juice, the cross elasticity is small—perhaps even zero.