Chapter 4: Elasticity of Demand Flashcards
Price elastic
A modest price change can cause a substantial change in quantity
Price inelastic
A substantial price change can cause only a modest change in quantity
Formula 1 for Price elasticity of demand
% change in quantity demanded of X/ % change in price of X
Formula 2 for Price elasticity of demand
(change in quant. demanded of x/ orig quant. demanded of x)/ (change in price of X/orig price of X)
When is demand elastic based on Ed?
absolute value of Ed will be greater than 1
When is demand inelastic based on Ed?
absolute value of Ed will be less than 1
When is demand unit elastic based on Ed?
absolute value of Ed is exactly 1
Perfectly inelastic demand
A price change results in no change in the quantity demanded (demand curve is a vertical line)
Perfectly elastic demand
At the ongoing market price, the firm is able to sell whatever the quantity it wishes to sell (horizontal demand curve)
Total-revenue test (elastic)
a decrease in price causes an increase in the total revenue
Total-revenue test (inelastic)
a decrease in price causes a decrease in the total revenue
Total-revenue test (unit elasticity)
a decrease in price leaves total revenues unchanged
4 determinants of price elasticity of demand
1) Substitutability
2) Proportion of income
3) Luxuries vs. Necessities
4) Time
Substitutability in terms of price elasticity of demand
The larger the number of substitute gods that are available the greater the price elasticity of demand
Proportion of income in terms of price elasticity of demand
The higher the price of a product relative to one’s income, the greater the price elasticity of demand for it (demands for big ticket items tend to be more price elastic
Luxuries vs Necessities in terms of price elasticity of demand
The demand for “luxurious goods” tends to be more elastic than the demand for “necessities)
Time in terms of price elasticity of demand
The demand for a product is more elastic the longer the time period under consideration
Habit formation
Consumers may not immediately reduce their purchases very much when the price of the beef rises by 10%, but in time they may shift to chicken, pork or fish
Product Durability:
Short-run demand for gasoline is more inelastic than its long-run demand. In the short-run people are stuck with their present cars but with rising gasoline prices, they will eventually replace them with more fuel efficient choices
The Law of Supply
Producers will supply more of a product when its price rises and vice versa
Price elasticity of Supply
Measures the responsiveness of the quantity supplied by the producers when the product price changes
Elastic supply
modest price changes cause substantial changes in quantity
Inelastic supply
Substantial price changes cause only modest changes in quantity
Formula for price elasticity of supply
Es= % change in Q supplied of x/% change in P of X
Elastic supply in terms of Es
Es > 1
Unit elastic supply in terms of Es
Es = 1
Inelastic supply in terms of Es
Es < 1
Factors affecting price elasticity of supply
Availability of inputs
Availability of substitutes
Transferable inputs
Time frame
Transferability of the inputs
If inputs can be easily transported from one production site to another an increase in the price of a product in one market will motivate producers in that market to transfer inputs from other markets
Time
The longer the time frame, the greater the quantity response and hence the smaller price change
If there is no time for producers to adjust to a price change, the supply is ________
perfectly inelastic
The short-run
enough time to adjust output by changing the variable inputs but not the fixed inputs
Formula for cross-elasticity of demand
Exy = % change in quantity demanded of X/ % change in P of Y
Formula for cross elasticity of demand (using avg)
Ex,y= (change in quantity demanded of X/ sum of new and old demand quantities/2)/ (change in P of Y/ sum of new and old P of Y/2
X and Y are substitute goods when
Ex,y > 0
X and Y are independent goods when
Ex,y=0
X and Y are complementary goods when
Ex,y < 0
Formula 1 for income elasticity of demand
EI= % change in quantity demanded of the good/ % change in income
Formula 2 for income elasticity of demand
EI= (change in Q demanded of X/ sum of new and old demand quant/2) / (change in income/ sum of new and old incomes/2)
Normal good
Demand increases when incomes increases and vice versa
Inferior good
Demand increases when income decreases and vice versa
Which consumer product suffer the greatest demand decreases during recession?
Automobiles and housing (high income elasticity coefficients)
