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
What is the income elasticity of demand? and calculation
.The income elasticity of demand measures the sensitivity of quantity demanded to a change in income. This can be positive/negative
. % change in quantity demand divided by %change in consumer income
What is a normal good related to income elasticity?
It has a positive income elasticity of demand
an increase in income leads to an increase in the quantity demanded e.g dairy products.
What is an inferior good related to income elasticity
It has a negative income elasticity of demand
an increase in income leads to a fall in quantity demanded e.g low quality meat
What is a luxury good related to income elasticity?
It has an income elasticity of demand greater than 1 (unit) e.g BMW
What is a necessity good related to income elasticity?
Has an income elasticity below 1 (unit). Can be an inferior or normal good. If normal e.g food the quantity demanded will still increase but not as much as recreational activities for example
