Chapter 6 Flashcards
Elasticity
a measure of how much one economic variable responds to changes in another economic variable
Price elasticity of demand
the responsiveness of the quantity demanded to a change in price
How is price elasticity of demand measured?
percentage change in quantity demanded / percentage change in price
What does PED always generate?
A negative number, presented in absolute value
Elastic demand
percentage change in quantity demanded is MORE than the percentage change in price PED > 1
MORE responsive to a change in price
LESS tolerant of price increases
Inelastic demand
percentage change in quantity demanded is LESS than the percentage change in price PED < 1
LESS responsive to a change in price
MORE tolerant of price increases
Unit-elastic demand
percentage change in quantity demanded is equal to the percentage change in price PED = 1
Perfectly elastic
the absolute value of price elasticity is equal to infinity, horizontal line
Perfectly inelastic
the absolute value of the price elasticity is equal to 0, vertical line
The midpoint formula
((Q2 - Q1) / average Q1,2) / ((P2 - P1) / average P1,2)
When do we use the midpoint forumla?
to ensure we have only one value of the price elasticity of demand between the same two points on a demand curve
Percentage change
yields a different amount depending on if the movement is up or down on the demand curve, issue is eliminated with the midpoint formula
What are some key determinants of price elasticity of demand?
- availability of close substitutes
- passage of time
- product - necessity or luxury
- definition of the market
- share of consumer’s budget accounted for by purchase
Availability of close substitutes
more substitutes - higher PED (vending machine)
less substitutes - lower PED (gas)
Passage of time
more time passes - higher PED
short-run - lower PED
Product
luxury - higher PED (boat)
necessity - lower PED (bread)
Market
narrow - higher PED (particular brand of green beans)
broad - lower PED (green beans in general)
Budget accounted for by consumer
high % of budget - higher PED (rent)
low % of budget - lower PED (pencils)
Total Revenue
Price * Quantity
If demand is inelastic…
Increase in price = increase in total revenue
decrease in price = decrease in total revenue
if demand is elastic…
increase in price = decrease in total revenue
decrease in price = increase in total revenue
at higher prices demand is
elastic
at lower prices demand is
inelastic
unit-elastic
between elastic & inelastic
Revenue
total money in
Profit
money made
Cross-Price elasticity of demand
percentage change in quantity demanded of one good / percentage change in price of another good
If the products are substitutes CPED will be
positive (two brands of tablet computers)
If the products are complements CPED will be
negative (tablet computers & applications downloaded from online stores)
If the products are unrelated CPED will be
zero (tablet computers & peanut butter)
Income elasticity of demand
a measure of the unresponsiveness of quantity demanded to changes in income
Formula for IED
percentage change in quantity demanded / percentage change in income
If income elasticity of demand is positive & less than 1 the good is
normal & a necessity (bread)
If income elasticity of demand is positive & greater than 1 the good is
normal & a luxury (high-end jewelry)
If income elasticity of demand is negative the good is
inferior (high-fat meat)
Price elasticity of supply
the responsiveness of the quantity supplied to a change in price
formula for PES
percentage change in quantity supplied / percentage change in price = (always generate a positive number)
Determinants of the price elasticity of supply
the supply being elastic or inelastic depends on the ability and willingness of firms to alter the quantity they produce as price increases
if supply is elastic..
the value of price elasticity is greater than 1
MORE responsive to a change in price, price increases less
if supply is inelastic…
the value of price elasticity is less than 1
LESS responsive to change in price, price increases more
if supply is unit-elastic…
the value of price elasticity is equal to 1
if supply is perfectly elastic…
the value of price elasticity is equal to infinity
horizontal line
if supply is perfectly inelastic…
the value of price elasticity is equal to zero
vertical line
