6) Elasticities

Question 1

What is the equation to work out PED??

Answer 1

%Change in the quantity demanded / % change in the price

Question 2

What values are associated to inelastic and elastic PEDs and what do they tell us??

Answer 2

Inelastic PED = <1; a change in price will have a proportionally less change in the QD

Elastic PED= >1; a change in the price will have a proportionally bigger change in QD

Question 3

What 5 factors influence PED??

Answer 3

1) price/ availability of substitutes
2) price/ availability of complements
3) the length of time - elasticity increases over time as other options become viable
4) necessity or luxury (necessity much more inelastic)
5) addictive/ habit forming goods eg tobacco, alcohol and coffee

Question 4

Why is considering elastic or inelastic PED useful for firms??

Answer 4

If firms face an elastic demand curve, a change in price will result in a proportionally larger increase in QD. therefore they should lower the price to increase total revenue

If firms face an inelastic demand curve, they have more freedom to increase prices as the proportional fall in demand will be less, which will increase revenue

Question 5

Why might considering PED not be helpful to firms??

Answer 5

Estimates of PED may be wrong and based off of historical information that proves to be unreliable / outdated ie consumer preferences or substitutes may have changed

Question 6

under what circumstances may a firm encounter inelastic demand?

Answer 6

When there are 0 or very few firms in the market, therefore a lack of substitutes (monopoly/ oligopoly). They have lots of market power allowing them to raise prices to increase revenue

Question 7

How might considering elasticities of demand be beneficial to the government??

Answer 7

TAX- inelastic demand means that taxes imposed on goods (resulting in an increase in price) will have a proportionally smaller fall in demand eg alcohol or tobacco. Therefore the customers pay a large amount of the tax burden. such goods can be targeted with indirect taxes as consumers are likely to continue paying them, raising tax revenue

SUBSIDIES- elastic PeD means that lower prices will have a proportionally larger increase in demand. Subsidising merit goods with positive externalities will therefore be beneficial when goods have elastic PEDs.

Question 8

Whats the equation for income elasticity of demand and what does it measure

Answer 8

%change in QD for a good / % change in income

looks at how quantity demanded for a good changes with income

Question 9

What YeD elasticity does luxury goods have??

Answer 9

more than 1; we assume luxury goods are being purchased when all normal goods have been bought

Question 10

What are normal goods and how elastic are they??

Answer 10

A normal good is any good where when income increases, demand for this good increases. They’re relatively inelastic ie between 0 and 1,

Question 11

What are inferior goods and how elastic are they

Answer 11

Cheap substitute goods; have a negative YED because as income increases, demand for them falls as people purchase better substitutes (normal goods)

Question 12

Why is considering YED useful for firms??

Answer 12

They can predict the impact of changes in income/ GDP on the demand for their goods eg luxury goods will expect a rise in demand for their goods larger than the rise in wages/ GDP

Question 13

Why might considering YED not be useful for firms or governments??

Answer 13

Unreliability of information in the long run due to changing consumer preferences

Question 14

Why is considering YED useful for the government??

Answer 14

They can predict the changes in government revenue earned from a chance in household income due to more spending which raises VAT receipts

Question 15

How do you measure XED??

Answer 15

% change in QD for good x / % change in the price of good Y

Question 16

What elasticity values and +/- sign do complements and substitutes have

Answer 16

Substitutes have a positive sign as an increase in the price of good Y which lead to an increase in the QD of good x, as it becomes a cheaper substitute

Complements have a negative sign; as the price of good Y falls, the QD of good x increases because the two goods go together and the price

Question 17

How does XED tell us how close the substitutes are??

Answer 17

the closer the substitutes / more competitive they are, the stronger / higher the PED. very close substitutes have strong elasticity because a small change in the price of one product will lead to a proportionally bigger change in the price of another

the opposite can be said about weak substitutes

Question 18

How can you tell if goods are unrelated

Answer 18

unrelated goods have a XeD of 0

Question 19

What are the advantages of firms knowing the XeD of their products??

Answer 19

If firms sell close substitutes, they can predict the impact of a change of their or their competitors price, and therefore price or advertise their product accordingly. A firm selling close complements will know the impact of another firm lowering their prices for the compliment ie their own demand and revenue will increase

Question 20

How is considering XED useful for firms and government

Answer 20

Government- providing goods like train services, they can see how a change in the price will affect the demand for other travel alternatives, and the negative externalities this will cause ie increased CO2 emissions

Firms can use XED to predict how the demand of their products will change with a change in the price of competitors, allowing them to launch advertising campaigns if necessary to mitigate this fall in demand

Question 21

what is the equation for PES and do we expect PES to be positive or negative and why??

Answer 21

% change in the Quantity supplied / % change in the price.
we expect PES to be positive because of the upwards sloping supply curve; higher prices incentivise higher supply to increase revenue

Question 22

What 4 factors can affect PES??

Answer 22

1) spare production capacity; firms can increase their output without a rise in cost if they have spare capacity
2) ease of mobility of factors of production; being able to get workers in quickly allows them to increase production faster, increasing elasticity
3) time period; in the long run elasticity increases because firms can completely change production to any level if given enough time
4) stocks of finished products; if they have large stock levels, they can supply higher amounts when the price increases

Question 23

What methods can be used by firms to increase their responsiveness to a change in price??

Answer 23

1) increase stocks/ storage of productcs
2) upgrade to the latest technology
3) zero hour contracts
4) increase shelf life of products
5) faster distribution systems
6) training more flexible workers who can do a range of jobs