Chapter 6: Elasticity Flashcards
Define elasticity
A measure of the sensitivity of one variable to changes in another variable
Define price elasticity of demand (PED)
A measure of the sensitivity of quantity demanded to a change in the price of a good or service
What’s the formula for PED?
% change in quantity demanded / % change in price
Define elastic
A term used when the price elasticity of demand is greater than 1 but less than infinity
Define inelastic
A term used when the price elasticity of demand is less than 1 but greater than 0
Is PED always negative?
Yes
Define unit elastic
A term used when the price elasticity of demand is equal to 1
Draw a diagram illustrating how the price elasticity of demand varies along a straight line
Figure 6.2
Why may firms have an interest in PED?
If they are considering changing their prices they will be eager to know the extent to which demand will be affected
Draw a diagram illustrating both elasticity and total revenue
Figure 6.4
When PED is elastic, for a price increase what happens to total revenue?
It falls
When PED is elastic, for a price decrease what happens to total revenue?
It rises
When PED is unit elastic, for a price increase what happens to total revenue?
It does not change
When PED is unit elastic, for a price decrease what happens to total revenue?
It does not change
When PED is inelastic, for a price increase what happens to total revenue?
It rises
When PED is inelastic, for a price decrease what happens to total revenue?
It falls
What can a firm do if it is aware of the PED of its product?
It can anticipate consumer response to its price changes which may be a powerful strategic tool
Draw a diagram illustrating perfectly elastic and perfectly inelastic demand
Figure 6.5
What’s the most important influence on PED?
The availability of substitutes for the good or service under consideration
If a good is a necessity then what is demand?
Inelastic
If a good is a luxury then what is demand?
Elastic
Name 2 other influences on PED
- The relative share of the good or service in overall expenditure
- Time period
Why is PED always negative?
There is an inverse relationship between quantity demanded and price
If PED is smaller than -1, demand is said to be?
elastic
If PED is between 0 and -1 demand is said to be
Inelastic
Name the 4 things the size of the PED is influenced by?
- Availability of substitutes
- Whether it is a luxury or necessity
- The relative share of expenditure on the good in the consumers budget
- The time period that consumers have to adjust
Define income elasticity of demand
A measure of the sensitivity of quantity demanded to a change in consumer incomes
What is income elasticity of demand also known as
YED
What is the formula for income elasticity of demand?
% change in quantity demanded / % change in consumer income
What value may YED be?
Positive or negative
For normal goods what is the value of YED?
Positive
For inferior goods what is the value of YED?
Negative
Define superior goods
One for which the income elasticity of demand is positive, and greater than 1, such that as incomes rise, consumers spend proportionately more on the good
Describe a YED of below -1
Elastic inferior good
Describe a YED of between -1 and 0
Inelastic inferior good
Describe a YED of 0
No relationship between income and quantity demanded
Describe a YED of between 0 and 1
Inelastic normal good
Describe YED of above 1
Elastic normal good - also known as a superior-good
Define cross elasticity of demand
A measure of the sensitivity of quantity demanded of a good or service to a change in the price of some other good or service
What’s the abbreviation for cross elasticity of demand
XED
What’s the formula for XED
% change in quantity demanded of good X / % change in the price of good Y
What does it mean if XED is positive?
An increase in the price of good Y leads to an increase in the quantity demanded of good X
What does a high value of XED indicate?
Two goods are very close substitutes
What does a negative value of XED indicate?
Two goods are likely to be complements
What does it mean if XED is negative?
An increase in the price of one good lead to a fall in the quantity demanded of another good
What does it mean if XED is zero?
The goods concerned were unrelated
Describe an XED of below -1
Strong complement
Describe a XED of between -1 and 0
Weak complement
Describe XED of 0
No relationship between the two goods
Describe XED of between 0 and 1
Weak substitute
Describe XED of above 1
Strong substitute
What does the competition and market authority have the responsibility of?
Safeguarding consumer interests by ensuring that firms do not exploit excessive market power
Define price elasticity of supply (PES)
A measure of the sensitivity of quantity supplied of a good or service to a change in the price of that good or service
What’s the equation for Price elasticity of supply
% change in the quantity supplied / % change in price
What will the value of the elasticity depend on?
How willing and able firms are to increase their supply
Define perfectly inelastic supply
A situation in which firms can supply only a fixed quantity, so cannot increase or decrease the amount available: elasticity of supply is zero
Define perfectly elastic supply
A situation in which firms will supply any quantity of a good at the going price: elasticity of supply is infinite
Draw a diagram illustrating perfectly elastic and perfectly inelastic supply
Figure 6.7
How is the PED informative?
It shows how buyers of the good are likely to respond to a price change
What will YED help to do?
Forecast changing demand if real incomes are increasing, or if the economy is heading into a recession
What does XED help with?
Anticipating changes in demand if the prices of other products are changing
Why may PES be expected to be greater in the long run compared to the short run?
Firms have more flexibility to adjust their production decisions in the long run
