CH9 Price elasticity of demand

Question 1

What is price elasticity of demand?

Answer 1

it is the measure of the extent to which quantity demanded responds to a change in price.
-in other words, price elasticity of demand measures the proportionate response of quantity demanded to a proportionate change in price

Question 2

The quantity demanded by a good is affected by what changes?

Answer 2

by changes in the price of the good, by changes in price of other goods, changes in income and changes in other relevant factors.

Question 3

What does income elasticity of demand measure?

Answer 3

income elasticity of demand measures the responsiveness of quantity demanded to changes in consumer incomes

Question 4

what does cross elasticity of demand measure?

Answer 4

measures the responsiveness of quantity demanded to changes in the price of another good.

Question 5

What is the formula used to calculate price elasticity of demand?

Answer 5

% change in quantity demanded / % change in price

Question 6

what is price elasticity of demand sometimes called and why?

Answer 6

it is sometimes called ‘own price elasticity of demand’ to distinguish it from cross price elasticity

Question 7

When is demand said to be price elastic?

Answer 7

when the value of elasticity is greater than 1

Question 8

what does is mean when demand for a good is price elastic?

Answer 8

it means that a percentage change in price will bring about an even larger percentage change in quantity demanded

Question 9

when is demand said to be perfectly elastic?

Answer 9

when a fall in price would lead to an infinite increase in quantity demanded whilst a rise in price would lead to the quantity demanded becoming zero

Question 10

when is demand said to be price inelastic?

Answer 10

when the value of elasticity is less than one

Question 11

what does it mean when demand for a good is price inelastic?

Answer 11

it means that a percentage change in price will bring about a smaller percentage change in quantity demanded

Question 12

when is demand said to be perfectly inelastic?

Answer 12

if the value of elasticity is zero (i.e. a change in price would have no effect on quantity demanded)

Question 13

when is demand of unitary elasticity?

Answer 13

when the value of elasticity is exactly 1

Question 14

what does it mean when demand is of unitary elasticity?

Answer 14

it means that a percentage change in price will lead to an exact and opposite change in quantity demanded

Question 15

what are the 2 determinants of price elasticity of demand? (two factors which affect it)

Answer 15

-the availability of substitutes
-time

Question 16

How does the availability of substitutes affect price elasticity of demand?

Answer 16

-the better the substitutes for a product, the higher the price elasticity of demand will tend to be.
-For instance, salt has few good substitutes. When the price of salt increases, the demand for salt will change little and therefore the price elasticity of salt is low. On the other hand, spaghetti has many good substitutes, from other types of pasta to rice, potatoes, bread and other foods. A rise in the price of spaghetti, all other food prices remaining constant, is likely to have a significant effect on the demand for spaghetti. Hence the elasticity of demand for spaghetti is likely to be higher than that for salt

Question 17

the more widely the product is defined, the fewer what?

Answer 17

the fewer substitutes it is likely to have

Question 18

how does time affect price elasticity of demand?

Answer 18

-the longer the period of time, the more price elastic is the demand for a product
-for instance, in 1973-74 when the price of oil quadrupled the demand for oil was initially little affected. In the short term the demand for oil was price inelastic. This is hardly surprising. people still needed to travel to work in cars and heat their houses. Oil had few good substitutes. Motorists couldnt put gas into their petrol tanks whilst businesses would not change oil-fired systems to run on gas, electricity or coal. However, in the longer term motorists were able to, and did, buy cars which were more fuel efficient. Oil-fired central heating systems were replaced by gas and electric systems. The demand for oil fell from what is would otherwise have been.
-it is argued that in the short term, buyers are often locked into spending patterns through habit, lack of information or because of durable goods that have already been purchased. In the longer term, they have the time and opportunity to change those patterns

Question 19

what is sometimes argued about necessities and luxuries?

Answer 19

it is sometimes argued that necessities have lower price elasticities than luxuries
-necessities by definition have to be bought whatever their price in order to stay alive. So an increase in the price of necessities will barely reduce the quantity demanded. Luxuries on the other hand are by definition goods which are not essential to existence. A rise in the price of luxuries should therefore produce a proportionately large fall in demand.
-there is not evidence, however, to suggest that this is true. Food, arguably a necessity, does not seem to have a lower elasticity than holidays or large cars, both arguably luxuries. Part of the reason for this is that it is very difficult to define necessities and luxuries empirically. Some food is a necessity but a significant proportion of what we eat is unnecessary for survival. It is not possible to distinguish between what food is consumed out of necessity and what is a luxury.

Question 20

what is sometimes argued about goods which form a relatively lower proportion of total expenditure?

Answer 20

-it is sometimes argued that goods which form a relatively lower proportion of total expenditure have lower elasticities than those which form a more significant proportion.
-a large car manufacturer, for instance, would continue to buy the same number of paper clips even if the price of paper clips doubled because it is not worth its while to bother changing to an alternative. On the other hand, its demand for steel would be far more price elastic.
-There is no evidence to suggest that this is true

Question 21

what is price elasticity of demand linked to?

Answer 21

-price elasticity of demand and changes in total revenue or total expenditure of a product are linked.

Question 22

what is total expenditure?

Answer 22

it is the amount that buyers spend on the product.

Question 23

what is total revenue?

Answer 23

it is the amount that sellers receive from selling the product

Question 24

what is the formula to calculate total expenditure or total revenue?

Answer 24

total expenditure: quantity purchased x price
total revenue: quantity sold x price