Chapter 6: Elasticity Flashcards
Define elasticity
- It is a measure of responsiveness or sensitivity
- how sensitive or responsive the dependent variable is to changes in the independent variable
Define elasticity coefficient
The value of the price elasticity
Practical examples of cause-effect relationships
- How responsive is investment spending to changes in the interest rate
- How responsive is government tax revenue to changes in taxpayers income
- How responsive will SA government revenue to the increased 15% VAT
- How responsive will the SA consumer spending be to the increased VAT
When is change in price elastic
When a change in price causes a larger change in quantity demanded or supplied
ep/es > 1
When is change in price inelastic
When a change in price causes a smaller change in quantity demanded or supplied
ep/es < 1
Give an example of how elasticity varies among products
- Products that are necessities are more insensitive to price changes
- A price increase of a good or service that is considered less of a necessity will deter more consumers
Name the types of elasticity
- Price elasticity of demand
- Price elasticity of supply
- Income elasticity of demand
- cross elasticity of demand
What are the characteristics of price elasticity of demand
- Concerned with the sensitivity of Qd to a change in the price of the product
- Formally defined as the percentage change in the Qd if the price of the product changes by 1% ceteris paribus
- With ep we measure how sensitive the quantity demanded is to change in the price
What is the importance of ep for businesses
- Can assist in understanding how changes in price of a product will impact the total revenue of the product
- Determination of prices that will yield maximum profit
- Design of other marketing policies and strategies
When is the point elasticity formula used
- Measures elasticity value at a single point on a curve
- Used if the price changes relatively small
When is the arc elasticity/midpoint formula used
- Used if there are larger price fluctuations
- Measures elasticity over a section of the curve or between points
- Use averages but simplified
Different categories of price elasticity of demand
- Perfectly inelastic = 0 (consumers buy at fixed rate Q regardless of price)
- Inelastic demand < 1 (Q<P)
- Elastic demand > 1 (Q>P)
- Unitary elastic = 1
- Perfectly elastic = infinity
Determinants of ep (demand)
- Substitutes: The larger the number of substitutes and the close of the substitutes are the greater the ep
- Complements: The price elasticity of demand tends to be low for highly complimentary products
- Type: demand for goods considered a necessity tend to be inelastic while demand for luxury goods will tend to be more elastic
- Time: Demand tends to be more price elastic in the long run then in the short run
- Income: The higher the fraction of income spent on the good the more elastic the demand will tend to be
What is income elasticity of demand
It measures the responsiveness of quantity demanded to changes in income
Positive income elasticity
- Income goes up, quantity demanded goes up or income goes down, quantity demanded goes down
- positive income elasticity = normal goods
- Positive but > 1 = luxury goods
- Positive and between 0 and 1 = essential good/ necessity
