4.1-4.2: Price elasticity of demand & more elasticities of demand Flashcards
Responsiveness of the quantity demanded of a good to a change in its price = what?
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
Define Price elasticity of demand
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
Define elasticity
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
What is a percentage change?
A percentage change = a proportionate change multiplied by 100.
Why is elasticity a units-free measure?
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
Is price elasticity of demand a positive or negative number?
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.
What does it mean if price elasticity of demand is 0?
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.
What does it mean if percentage change in Qd = percentage change in price?
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.
What does it mean if price elasticity of demand is infinite?
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
When are goods elastic?
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.
When are goods inelastic?
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.
The elasticity of demand for a good depends on:
The closeness of substitutes
The proportion of income spent on the good
The time elapsed since the price change
How does Closeness of Substitutes
affect elasticity of demand?
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.
Define necessities
Necessities = goods like food and housing; need for living
A necessity has poor substitutes, so it generally has an inelastic demand.
Define luxuries
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.
How does Proportion of Income Spent on the Good affect elasticity of demand?
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
How does Time Elapsed Since Price Change affect elasticity of demand?
The longer the time that has elapsed since a price change, the more elastic is demand.
**More inventions and substitutes are made (other alternatives)
Elasticity of demand is the same as slope. True or false?
FALSE
Explain varying elasticities on a linear demand curve.
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.
How does the change in total revenue depends on the elasticity of demand?
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)
Which elasticity is total revenue at a maximum?
At unit elasticity
What is the total revenue test?
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.
Define income elasticity of demand
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.
Only the absolute value matters for income elasticities. True or false?
Income elasticities of demand can be positive or negative
What are the three ranges of income elasticity?
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.
What is cross elasticity of demand?
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.
If the cross elasticity of demand is positive…
demand and the price of the other good change in the same direction, so the two goods are substitutes.
If the cross elasticity of demand is negative…
demand and the price of the other good change in opposite directions, so the two goods are complements.
How does the magnitude of the cross elasticity of demand determine how far the demand curve shifts?
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.
