Demand and Supply Elasticities Flashcards
What is the price elasticity of demand?
Measures the sensitivity of the quantity
demanded of a good to a change in its price
How is the price elasticity of demand calculated?
The % change in quantity demanded divided by the %change in price
What are alternative versions of the same formula?
=(change in quantity/change in price)x(P/Q)
=change in log quantity/change in log price
When is demand elastic?
. when the price elasticity (ignoring the negative sign) is greater than -1
. i.e. when the negative % change in quantity demanded exceeds the % change in price
e.g. if quantity demanded falls by 7% in response to a 5% increase in price
elasticity is -7 / 5 = -1.4
When is demand inelastic?
when the price elasticity lies between -1 and 0
i.e. when the negative % change in quantity demanded is smaller than the change in price
.g. if quantity demanded falls by 3.5% in response to a 5% increase in price
elasticity is -3.5 / 5 = - 0.7
When is demand unit elastic?
. when the price elasticity is exactly -1
. i.e. when the negative % change in quantity demanded is equal to the change in price
. e.g. if quantity demanded falls by 5% in response to a 5% increase in price
elasticity is -5 / 5 = -1
What is the area of any rectangle under a unit elastic demand curve?
With unit elasticity, the area of
Any rectangle below the curve
Which touches the curve is always
The same
What is the Price elasticity along a linear demand curve and why?
The price elasticity varies along the length of a straight-line demand curve.
Elastic at the top, unit elastic in the middle and inelastic at the bottom
Why:
Change in demand per unit change in price is constant with a linear curve.
But P/Q is low as you get towards the right-
Hand end of the demand curve.
So (change in Q/change in P) x (P/Q) is lower.
What determines the price elasticity? and give an example
The ease with which consumers can substitute another good.
e.g
. consumers can readily substitute one brand of detergent for another if the price rises,
so we expect demand to be ELASTIC,
. but if all detergent prices rise, the consumer cannot switch,
so we expect demand to be INELASTIC.
How does elasticity change in the short and long run?
. more elastic in the long run-if price change persists you could but smaller car
. but relatively inelastic in the short run-consumers may not be able or ready to adjust expenditure e.g can’t sell a big car to adjust to increase in price of diesel
What happens to total revenue for a price increase/decrease for elastic demand?
. For a price increase, TR decreases
. For a price decrease, TR increases
What happens to total revenue for a price increase/decrease for unit elastic demand?
For a price increase, TR does not change
. For a price decrease, TR does not change
What happens to total revenue for a price increase/decrease for inelastic demand?
For a price increase, TR increases
. For a price decrease, TR decreases
What is the cross price elasticity of demand? and calculation
The cross price elasticity of demand for good i
with respect to the price of good j. This can be positive/negative.
% change in quantity demanded of good i divided by the % change in the price of good j
When is the cross price elasticity positive or negative?
. The cross price elasticity tends to be positive
if two goods are substitutes : e.g. tea and coffee
. The cross price elasticity tends to be negative
if two goods are complements e.g. tea and milk
