Ch 3: Elasticity Flashcards
What is elasticity?
resposiveness of quantity demanded or supplied to a change in price
What is price elastic demand?
buyers are sensitive to a price change. A price elastic good/service is one where the change in price leads to a larger than proportionate change in quantity demanded.
What is price inelastic demand?
buyers are not sensitive to a price change. A price inelastic good/service is one where the change in price leads to a smaller than proportionate change in quantity demanded.
How is price elasticity of demand calculated?
Ed > 1: demand is price elastic
Ed < 1: demand is price inelastic
Ed = 1: demand is unitary elastic
Ed = 0: demand is perfectly inelastic (vertical curve)
Ed =∞: demand is perfectly elastic (horizontal curve)
steeper the curve → lower the elasticity
flatter the curve → higher the curve
What are factors affecting elasticity of demand?
- availability of substitutes- the greater the number of close substitutes a good has, the more price elastic its demand. So food, water or petrol would be very inelastic, however the demand for a particular brand of petrol would be very elastic- we can generalise by saying the price elasticity of a brand is greater than the price elasticity for the class of good
- whether the good is a necessity or a luxury- a necessity does not have a substitute
- proportion of income spent- the less of an income a good takes up, the more price inelastic it is
- time- if consumers have time to respond to a price change, then demand will be more price elastic. In the very short run, demand for most commodities will be relatively inelastic because consumers do not have the time to adjust their consumption or find substitute products. As the time period increases though, it become more elastic
What is income elasticity of demand (Ey) and how is it calculated?
responsiveness of demand to a change in income
What is income elasticity of demand for a normal good?
demand increases as income increases
- positive income elasticity (Ey > 0)
- income elastic goods
- Ey > 1
- luxury goods
- income inelastic goods
- 0 < Ey < 1
- necessity goods
What is income elasticity of demand for an inferior good?
- demand decreases as income increases
- Ey<0
- negative income elasticity
- home brand or junk food
What is the relationship between income elasticity and price elasticity and why is income elasticity useful?
Often goods that are income elastic are price elastic and goods that are income inelastic are price inelastic. Income elasticity is useful in predicting which industry sectors will expand as incomes in the community rise.
What is cross elasticity of demand (Eab)?
responsiveness of the demand for one good (a) to a change in the price of a related good (b)
What is cross elasticity of demand for substitute goods?
- positive cross elasticity of demand
- rise in price of good a → rise in demand for good b
- butter and margarine
What is the cross elasticity of demand for complement goods?
- negative cross elasticity of demand
- rise in price of good a → fall in demand of good b
- petrol and cars
How is total revenue calculated?
total revenue/expenditure = P x Q
How is total revenue affected if demand is elastic and there is an increase in price?
If demand is elastic, total revenue will fall because the percentage decrease in Qd will be greater than the percentage increase in price (↑P = ↓TR while a ↓P = ↑TR
How is total revenue affected if demand is inelastic and there is an increase in price?
if demand is inelastic, total revenue will increase as the fall in Qd will be smaller than the rise in price (↑P = ↑TR while a ↓P = ↓TR)
How is total revenue affected if demand is unitary elastic and there is an increase in price?
if demand is unitary elastic, total revenue/expenditure would not change due to a price change because percentage change in price and quantity is equal
What is price discrimination and what are two examples of it?
different consumer groups have a different price elasticity of demand and firms can use this information to change different prices and increase their total revenue
i.e.:
- females pay more at a hair salon because their demand for these services are relatively inelastic, firms are maximising on revenue. Hair salons also boost revenue by charging males at a much lower price because their demand is relatively elastic
- fims charge a higher price for adults as they have more inelastic demand. Students and seniors are charged a lower price because they have a lower income and a more elastic demand therefore maximising revenue
What is price elasticity of supply?
responsiveness of quantity supplied to a change in price
How is price elasticity of supply calculated and what does it mean?
% change in Qs > % change in P = >1 = supply is price elastic
% change in Qs
What are determinants of supply elasticity?
time
- if the producer can respond quickly to a price change then supply will be elastic
- in the very short run, it may be difficult for a producer to suddenly increase output, supply will therefore tend to be price inelastic
- as time increases, producers will be able to obtain more inputs and expand output more easily so as time increases, the supply of most goods becomes more elastic
nature of the industry
- the supply of agricultural products tends to be relatively price inelastic as it takes a reasonable amount of time to produce
- the supply of manufactured goods is more price elastic as firms can quickly respond to an increase in price as they are relatively easy to produce i.e. electronic goods
What is the purpose of tax?
The key purpose of a tax is to raise revenue for the government, however it can also be used to reduce the production of goods if they are deemed to have a negative impact on society.
What is the effect of a tax?
a tax will always shift the supply curve to the left, increase the price paid by consumers, decrease price received by producers and decrease quantity sold
What is the effect of a tax on an elastic good?
a tax on elastic goods is not very effective or profitable as consumers will turn to cheaper substitutes. Taxing an elastic good will also have a large effect on the producer, potentially causing them to go out of business
What is the effect of a tax on an inelastic good?
a tax on inelastic goods would be more effective and earn the most revenue as consumers can’t switch to another good and pay most of the tax
