Chapter 4 : Elasticity Flashcards
What is an elastic demand?
Demand is elastic when the qt demanded is relatively responsive to changes in price
What is an inelastic demand?
Qt demanded is relatively unresponsive to changes in price (Ex. fuel)
Impact of an elastic demand on equilibrium price and equilibrium quantity
More elastic demand = big change in equilibrium qt and little change in equilibrium price due to any given shift in the supply curve
Equation for price elasticity of demand
N = percentage change in qt demanded / percentage change in price
How to calculate the percentage change
for any given interval, % change in qt demanded is delta Qd/the average Qd of that interval
Does a linear demand curve have the same price elasticity of demand over the entire curve?
No : moving downward, price elasticity falls continuously due to the increase of the average of Q and the decrease of the average of P
What are the extreme cases of price elasticity and what do they mean?
N = infinity : perfectly elastic ->horizontal line
N = 0 : perfectly inelastic -> vertical line
What does an N = 1 mean in regards to price elasticity of demand?
It means that the demand is unit elastic.
What three factors can impact price elasticity of demand?
- Availability of substitutes : more substitutes = more elastic demand (people can switch easily)
Less substitutes = less elasticity (consumers forced to stick to product -eg. fuel) - Importance of the good in the consumer’s budget
Small fraction (eg salt) : inelastic
Large fraction : elastic
(Higher price elasticity for more expensive items) - Short run and long run
Elasticity increases with times. Two curves are often useful.
Difference in substitute availability for narrowly-defined products vs for broadly-defined products
Narrowly-defined products = more substitutes = more elastic
Broadly-defined products = less substitutes = less elastic
What is the total expenditure?
It is the total amount of money spent by buyers for all of their products.
TR = Price x Quantity
How does total expenditure change according to price elasticity when price falls?
- Elastic demand : expenditure ++
- Inelastic demand : expenditure –
- Unit elastic : no change
How does total expenditure change according to price elasticity when price rises?
- Elastic demand : expenditure –
- Inelastic demand : expenditure ++
- Unit elastic : no change
Equation for Ns
Ns = (% change in qt supplied) / (% change in price)
Determinants for price elasticity of supply
- Ease of substitution :
+ easy to switch to production of substitute = elastic supply
- easy to switch to production of a substitute = inelastic supply - Short and long run
Short : inelastic
Long : elastic
What is an excise tax
= Tax on the sale of a particular product.
Raises the price paid by consumers but reduces the price received by producers.
Question of tax incidence
- If the demand is more elastic than the supply, the suppliers will bear most of the tax burden
- If the demand is more inelastic than the supply, the consumers will bear most of the tax burden
The least elastic bears the burden
Who bears the burden of payroll taxes?
- Elastic demand of labourers : firms pay most of the tax
- Inelastic demand of labourers : they pay most of the tax
Equation of income elasticity of demand
Ny = % change in qt demanded /% change in income
Interpreting Ny
if Ny > 0, the good is a normal good. This means that the quantity demanded varies more than the change in income
if Ny < 0, the good is an inferior good. This means that there is less qt demanded despite the increase in income
0 < Ny < 1
Income inelastic : necessity. The more necessary an item is in the consumption pattern of consumers, the lower its income elasticity
1 < Ny
Income elastic : luxury
Cross price elasticity of demand equation (Nxy)
Nxy = % change in qt demanded of X /% change in price of Y
Interpreting Nxy
If Nxy >0 : X and Y are substitutes : a rise in the price of Y leads to an increase in the purchase of X
If Nxy <0 : X and Y are complements : a rise in the price of Y leads to a decrease in the demand of X as well
