CH3 ELAST OF DD n SS Flashcards
Define price elasticity of demand.
(PED)+Formula
PED measures the responsiveness of quantity demanded of a good due to a change in its price, ceteris paribus.
PED= %change in qty demanded for good A/%change in price of good A
What is the significance of the magnitude of the PED?
Demand is price elastic : |PED| > 1
Demand is price inelastic: |PED|< 1
Describe a good being price elastic.
A change in price results in a more than proportionate change in quantity demanded. The more price elastic the demand, the gentler the slope of the demand curve.
Describe a good being price inelastic.
|PED|<1
Change in price results in a lass than proportionate change in quantity demanded. The more price inelastic the demand, the steeper the slope of the demand curve.
What factors affect the PED for a Good or Service?
HINTS
Habits
Income (proportion)
Necessity (Degree)
Time
Substitutes
How does habit make a good price elastic? (Demand)
Demand is price inelastic if people consume the good out of sheer habit or are addicted to the good. (e.g cigarettes or alcohol)
This may be habitual- a price increase in cigs or alc may not lead to a significant fall in qty demanded as many habitual consumers may not easily change their consumption habits and cut down on their cigarette or alc consumption.
How does proportion of income spent on the good affect PED?
**The higher the proportion of income spent on the good, the higher the price elasticity of demand. **A rise in the price of any big-ticket item has a large impact on how consumers can spend on other goods, since by not doing so would mean a considerable sacrifices that has to be made of other purchases.
**The smaller the proportion of income spent on the good, the lower the price elasticity of demand. **
How does the degree of necessity affect the PED of the good?
Demand for a necessity tends to be price inelastic as there is a limit on how much quantity demanded changes when price changes. The higher the degree of necessity, the lower is the PED
Demand for the luxury goods are price elastic as consumers can do without it when the price rises. The lower the degree of necessity, the higher the PED.
How does time period affect PED?
The longer the time period, the more price elastic the demand.
How does the number of substitutes affect the PED?
The larger the number of subtitutes, the greater the price elasticity of demand. The more closely related the goods, the higher the price elasticity of demand
Define PRICE ELASTICITY OF SUPPLY
definition+formula
PES measures the responsiveness of quantity supplied of a good due to a change in the price of the good itself, ceteris paribus.
PES= (% change in qty supplied of A)/(% change in price of good A)
What is the significance of the magnitude of PES?
Supply is price elastic if |PES|>1
(Change in price results in a more than proportionate change in quantity supplied, gentler slope)
Supply is price inelastic |PES|<1
(Change in price results in a less than proportionate chanhge in qty supplied, steep slope)
What factors affect PES?
Time period
Mobility of factors of production
Spare capacity of firms
Level of stocks or inventories
Why does time period affect the PES?
In the very short run, the producer is unable to respond to a price change because it is very difficult to increase the qty of any product. Supply is restricted to qty available in the market. Thus, supply is almost perfectly price inelastic.
In short run, supply is price inelastic
In long run supply is price elastic.
How does mobility of factor of production affect PES?
The greater the ease and speed that resources can be shifted out of 1 line of production to the next, the greater the responsiveness of qty supplied to price changes.
Supply is price elastic if so.
How does spare capacity of firms affect PES?
Spare capcity measures the extent to which an industry or economy is operating below sustainable lvl of production.
there are spare factor CELL
How does lvl of stocks affect PES?
Firms that have a high level of stocks of output have the ability to respond to a rise in price. Supply is price elastic
What is definition and formula of YED?
Price elasticity of demand measures the responsiveness of demand for a good due to a change in consumer’s income, ceteris paribus.
YED= (%change in demand for a good)/%change in income
What is the significance of the sign and magnitude of YED?
Normal goods have +ve YED.
Luxury goods- YED >1
Necessities- YED<1
Inferior goods have -ve YED.
Define cross elasticity of demand.
def and formula
XED measures the responsiveness of the demand for a good due to changes in the price of another good, ceteris paribus.
XED= %change in demand for A/%change in price for B
What is the significance of the sign of the XED?
Positive XED- demand for a good and the price for another good changes in the same direction, goods are substitutes
Negative XED- demand for a good and the price of another good change in opp. directions, goods are complements
XED is 0, goods unrelated
How does the relationship between goods affect XED for a good or service?
The stronger the relationship between 2 goods, the higher the magnitude of XED.
