Chapter 4 - Elasticity of Demand and Supply

Question 1

Define price elasticity of demand (PED)

Answer 1

PED measures the responsiveness of quantity demanded of a good due to change in its price, ceteris paribus.

PED is elastic when magnitude > 1
Change in price results in more than proportionate change in QD (responsive)

PED is inelastic when magnitude < 1
Change in price results in less than proportionate change in QD (not very responsive)

Question 2

What is the formula for PED/PES/WED/WES

Answer 2

(% change in QD/QS) / (% change in price)

Question 3

When is demand perfectly price elastic?

Answer 3

Occurs when PED is infinite. A change in price results in infinitely large change in QD. QD is extremely responsive.

Question 4

When is demand perfectly price inelastic?

Answer 4

Occurs when PED = 0. A change in price results in no change in QD. QD is totally unresponsive.

Question 5

When is demand unit price elastic?

Answer 5

Occurs when PED = 1. Change in price results in proportionate change in QD. Demand curve is rectangular hyperbola.

Question 6

What are the factors affecting PED?

Answer 6

• Number and closeness of substitutes in the same price range (narrower the definition, higher PED)
• Proportion of income consumers spent on good (higher proportion, higher PED)
• Degree of necessity of good to consumers (necessity vs luxury)
• Habit of consumers (greater chance of habit formation, lower PED)
• Time period

Question 7

What are necessities?

Answer 7

Necessities are goods that we think of as essential for our survival and for which there are no close substitutes.

Question 8

What are luxury goods?

Answer 8

Luxury goods are goods that we can easily do without, non-essential for survival.

They usually take up large proportion of income, hence PED is even greater.

Question 9

Define price elasticity of supply (PES)

Answer 9

PES measures the responsiveness of quantity supplied of a good due to a change in the price of the good itself, ceteris paribus.

Question 10

When is supply unit price elastic?

Answer 10

Occurs when PES = 1. A change in price results in a proportionate change in QS. Supply curve is any straight line starting from origin.

Question 11

List down the factors affecting PES

Answer 11

• Time period (very short, short, long run)
• Mobility and substitutability of factors of production
• Spare capacity of firms
• Level of stocks or inventories
• Complexity of production process

Question 12

Define wage elasticity of demand (WED)

Answer 12

WED measures the responsiveness of quantity demanded for labour due to a change in wage rate, ceteris paribus.

Question 13

List down the factors affecting WED

Answer 13

• Availability of substitutes
• Proportion of labour cost in total cost
• PED for final good or service (derived demand)

Question 14

Define wage elasticity of supply (WES)

Answer 14

WES measures the responsiveness of quantity supplied of labour due to a change in wage rate, ceteris paribus.

Question 15

List down the factors affecting WES

Answer 15

• Skills and education level
• Time Period