Chapter 4 Flashcards
What is elasticity?
How responsive is the quantity changes in price
Very response: elastic (flat)
Not very responsive: inelastic (steep)
location + inclination
“temp” + “pressure”
thermometer + barometer
(P/Q) x (1/slope)
What are the four types of elasticity?
- Price elasticity of demand
- Measurement
- Determinants
- Elasticity and Total Revenue
- Price elasticity of supply
- Measurements
- Determinants
- Income elasticity of demand
- Cross elasticity of demand
What are the three working definitions of price elasticity of demand?
- (P/Q) x (1/slope)
- ΔQd/ΔP
- responsiveness of quantity demanded to change in price (i.e., price sensitivity)
What is the equation for responsiveness of Qd to a change in P (i.e., relative change in Qd / relative change in P) ?
((Q2-Q1)/(Q2+Q1)/2)
((P2-P1)/(P2+P1)/2)
…
quantity difference / quantity average
price difference / price average
Describe elasticity of equilibrium price and quantity resulting from any given shift of the supply curve.
The more elastic is demand, the less the change in equilibrium price and the greater the change in equilibrium quantity resulting from any given shift in the supply curve.
Describe relatively elastic demand.
Describe relatively inelastic demand.
Describe the location component of elasticity.
location (i.e., position) + inclination = price elasticity of demand
Q is getting bigger, so P/Q is getting smaller.
Going from D1 to D2, elasticity decreases!
Describe the inclination component of elasticity.
location (i.e., position) + inclination = price elasticity of demand
D2 slope is steeper than D1, but the location is the same
D2 has a lower elasticity than D1
Describe the elasticity of these demand curves.
perfectly inelastic → e = 0
inelastic → e < 1
elastic → e > 1
perfectly elastic → e = ∞
unitary elasticity → e = 1
How is price elasticity of demand affected by availabiltiy of substitutes of outputs?
The more/better substitutes of goods/services, the higher the elasticity.
Compare price elasticity of demand of close substitutes with poor substitutes.
How is the price elasticity of demand affected by the consumer’s budget?
Big-ticket items tend to have higher elasticity.
e.g., the PeD of a car will be higher than PeD of an apple
How does time affect elasticity?
5. Summary
- elasticity increases over time
- Reason: over time, substitutes appear
- In the long run, all goods have substitutes
Give examples of determinants of price elasticity of demand.
- Income
- Range of price
- Joint demand
- Substitutes
- Demand can be postponed or not
- Several uses of commodity
- Nature of commodity
- Money spent
What is total revenue?
Price * Quantity demanded
PQ
As the price falls on an elastic demand curve, what happens to total revenue?
Total revenue increases as price falls
As the price falls on an inelastic demand curve, what happens to total revenue?
Total revenue decreases as price falls.
Describe how elasticity changes along a straight line demand curve.
Describe the change in total revenue and elasticity as price falls.
What is the price elasticity of supply?
Relative change in Qs / relative change in P
I.e., price sensitivity
Responsiveness of quantity supplied to a change in price
(P/Qs) x (1/slope)
Differentiate between relative change and percent change.
Relative change is the difference divided by the average; whereas, percent change is the difference divided by the initial value.
Describe the elasticity of these supply curves.
Any straight line supply curve that goes thru the origin has unitary elasticity.
Describe how availability of substitutes of inputs affects the price elasticity of supply.
The more/better substitutes of factors, the higher the elasticity.
Describe the effect of time on price elasticity of supply.
Supply is more elastic in the long term
Reason: production efficiencies keep costs down
What is income elasticity of demand?
relative change in Qd / relative change in Y
responsiveness of Quantity demanded to a change in income
Describe income elastic and income inelastic.
Describe the question of tax incidence.
Who bears the burden of the excise tax, a tax on the sale of a particular product? The burden of an excise tax is distributed between consumers and sellers in a manner that depends on the relative elasticities of supply and demand. An excise tax raises the price paid by consumers but reduces the price received by producers.
With an excise tax, how do the consumer price and the seller price differ?
With an excise tax, the price paid by the consumer is pc and the price received by the seller is ps. The consumer price and the seller price differ by the amount of the tax, t.
Describe income elasticity of normal goods.
- If income elasticity is positive but less than one, demand is income inelastic.
- If income elasticity is positive and greater than one, demand is income elastic.
- The more necessary an item is in the consumption pattern of consumers, the lower is its income elasticity.
- Products for which the income elasticity of demand is positive but less than 1 are necessities.
- Products for which the income elasticity of demand is positive and greater than 1 are luxuries.
Describe income elasticity of inferior goods.
- Inferior goods have a negative income elasticity because an increase in income actually leads to a reduction in quantity demanded.
- It is generally easier to find examples of inferior goods for an individual than it is for the market as a whole.
Describe the cross elasticity of demand.
- Responsiveness of Qd of X to a change in P of Y.
- The change in the price of good Y causes the demand curve for good X to shift.
- If X and Y are substitutes, an increase in the price of Y leads to an increase in the demand for X. The demand curve for X shifts rightward.
- If X and Y are complements, an increase in the price of Y leads to a decrease in the demand for X. The demand curve for X shifts leftward.
What is an income elastic (‘luxury’) good?
When change in income leads to more than proportionate change in quantity demanded, income elasticity is greater than 1.
What is an income inelastic (‘necessity’) good?
When change in income leads to less than proportionate change in quantity demanded, income elasticity of demand is less than 1.
Compare the income-consumption line for normal goods and inferior goods.
What determines income elasticity of demand? [3]
- characteristics of the good
- For given level of real income the more necessary a good is, the lower the elasticity.
- Necessity: e < 1 (decrease income by 10% → decrease Qd by 5%)
- Luxury: e > 1 (decrease income by 10% → decrease Qd by 15%)
- Level of consumer’s income
- As income rises demand shifts from necessity to luxury
- Increase income → demand shifts (e.g., home to restaurant)
- Reason: preferences are relative
- Note on inferior goods
- Inferior good = as income rises, consumer buys less
What is the equation for cross elasticity of demand?
Describe how the cross elasticity of demand is used to define the market.
Substitutes are in the same market (i.e., they are competitors)
Complements are in different markets (i.e., they do not compete)
