Chapter 5 - Elasticity and Its Application Flashcards
Price Elasticity of Demand (PED)
Measures the specific amount of change in quantity demanded as a result of a price change. If the QD changes a lot it is elastic.
Availability of Close Substitutes (Influences on PED)
If a good has a close substitute that good will most likely be elastic because it is easy to simply switch to a different good when the price increases of the original good.
Necessities versus Luxury (Influences on PED)
Necessities usually have inelastic demands because people need these goods so they are willing to pay more for them, versus with luxuries people are less likely to pay a higher price if they don’t necessarily need them.
Necessary = inelastic
Uanessacry = elastic
Definition of the Market
A broader market like food is inelastic because you can’t substitute food in general, but a market like different kinds of chips is elastic because each type of chips has a substitute, so it is elastic.
Time Horizon
A good may be inelastic at first but overtime people might find solution or substitutes for this good, making it elastic in the long run. (ex. electric cars are a substitute for gasoline but no one buys a car at the first price change in gas, its a longer process)
Computing the PED
PED = % change in QD / % change in price
Midpoint Method
PED = (Q2 - Q1)/[(Q2+Q1)/2] / (P1-P2)/[P2+P1)/2]
Numbers for Elasticity
When demand elasticity is greater than 1, it is elastic.
When demand elasticity is less than 1, it is inelastic.
When demand elasticity is exactly 1, it has unit elasticity.
Elasticity Curves (Demand)
Completely vertical - Perfectly inelastic, people will buy a set quantity at any price
Steeper curve - Inelastic, elasticity is less than 1
“Perfect Curve” - % change in both price and quantity is the same therefore it has unit elasticity
Flatter curve - Elastic, elasticity is more than 1
Completely horizontal - Perfectly elastic, people will buy any quantity at a certain price.
Total Revenue
TR = Price x Quantity
Changes in TR When Price Changes
Inelastic demand - with price changes you may still profit (you can still lose profit but it is less likely with inelastic goods) because the loss of quantity does not exceed the money gained from the price change (the “extra revenue area” is greater than the quantity area)
elastic demand - with a price change, quantity is lost on a larger scale and therefore you are losing revenue by increasing price (the “quantity area” of the graph is larger than the extra revenue area)
Elasticity Along a Demand Curve
Points with a low price but high quantity means it is inelastic
Points with a high price but low quantity means it is elastic
Income Elasticity of Demand
How much people change the quantity of demand based on their income.
Normal goods and inferior goods.
Cross-Price Elasticity of Demand
This measures how much the quantity demanded of one good is affected by the price of another good
Substitutes and Complements
Price Elasticity of Supply
If quantity supplied responds a lot to a price change, it is elastic
If it responds minimally, it is inelastic
It measures a sellers willingness and ability to change the amount of goods they produce in response to a price change
In most markets the time period of elasticity is a key factor. Most firms cannot increase production in short periods of time.
Supply is usually more elastic in the long run.
