Economics Topic 3 - Elasticity Flashcards
Price Elasticity of Demand
Measures the responsiveness of quantity demanded to changes in price of a good or service
Compare price elastic demand and price inelastic demand
- Elastic –> Qd is relatively responsive to change in price e.g. fast food, fruits
- Inelastic –> Qd is relatively unresponsive to change in price e.g. Petrol, cigarettes, bread
Factors affecting price elasticity of demand
- Availability of substitutes
- Whether the good is a necessity or a luxury
- Proportion of income spent
- The period considered (time)
- The definition of the market
How does the definition of the market affect price elasticity of demand
The demand for a good in a broadly defined market will be more inelastic than the demand for a good in a narrowly defined market.
Broad market e.g. Market for petrol –> less responsive to price change
Narrow market, e.g. Brands of petrol –> more responsive/elastic to price change
What happens to the revenue of products when price decreases based on the price elasticity of the product
Price elastic products: Total revenue would increase
Price inelastic product: Total revenue would decrease
Unit Elastic: No change in total revenue
How does the period considered (time) affect the price elasticity of demand
If consumers have more time to respond to a price change, then demand will be more price elastic. In the short run, consumers don’t have the time to adjust their consumption or to find substitutes so demand will be more inelastic. As time increases it becomes easier to change consumption patterns and so demand becomes more elastic.
E.g. If the petrol price change was sudden it would be more inelastic but if more time has passed then more responsive and elastic e.g. Taking transport
What is perfectly elastic demand
Ed = infinity
○ Change in price causes infinite change in qd
§ If price changes, qd falls to zero
§ Reflects perfectly competitive market where firms are price takers
What is perfectly inelastic demand
Ed = 0
○ Changes in price cause no change in qd
§ Quantity demanded remains the same regardless of price
§ Reflects a market where there is fixed demand regardless of price e.g. Insulin for diabetic
What is the % change (point method) which is used to calculate price elasticity
% change in quantity demanded/ % change in price
What does the result of price elasticity calculations show for the elasticity of a product based on the number
Ed>1 –> change in Qd is proportionally greater than the change in price –> good is price elastic
Ed=1 –> change in Qd is proportionally the same as the change in price –> good is unitary elastic
Ed<1 –> change in Qd is proportionally less than the change in price –> good is price inelastic
How do you calculate total revenue
TR (TE) = P x Q
What is the percentage change method to calculate price elasticity
Change in Q/Q Avg * P Avg/ Change in P
Who does the tax burden fall on during price inelastic demand
Amount of tax revenue is higher and burden of tax falls more on consumers –> relatively small change in Qd
Who does the tax burden fall on during price elastic demand
Amount of tax revenue is lower and the burden of the tax falls more on producers –> relatively large change in Qd
How does the availability of substitutes affect the price elasticity of demand
The greater the number of substitutes a good has, the more elastic its demand. If the price of good X rises and it has many substitutes, then consumers will be more sensitive to price changes because they can substitute the good for other like goods. e.g. petrol can’t be substituted
How does whether a good is a necessity or luxury affect the elasticity of demand
Necessities - relatively inelastic, e.g food
Luxury goods - relatively elastic, e.g. jewlry
How does the proportion of income spent affect the elasticity of demand
Expensive goods are likely to be more price elastic than cheaper goods because they take up a larger proportion of a consumer’s income
What is the price elasticity of supply
A measure of the responsiveness of quantity supplied to a change in price.
Es = (% change in Qs)/(% change in P)
What is the formula for price elasticity of supply
Es = (Change in QS/Qs) x (P/Change in P)
What are factors affecting the price elasticity of supply
- Time
- Nature of the Industry
- Ability to Store Inventories
How does time affect the price elasticity of supply
Over a short period the supply of a good would be relatively inelastic, but over a longer span, a producer could respond to a price change making the supply relatively elastic
e.g. oil
How does the nature of the industry affect the price elasticity of supply
The supply of agricultural products tends to be relatively price inelastic, while the supply of manufactured goods tends to be more price elastic.
Agricultural products take time to produce –> producers can’t quickly respond
Manufactured goods are relatively easy to produce, and firms can quickly expand output after an increase in price
How does the ability to store inventories affect the price elasticity of supply?
Goods that can be stocked allow producers to respond relatively quickly to a change in price, making them elastic to price (non-perishables, canned)
Stock that is perishable cannot be stored readily, so their supply would be relatively elastic
Is tax revenue higher on inelastic demand or elastic demand, and why
Inelastic demand because consumers are less responsive to price changes, meaning that even with a tax-induced price increase, the quantity demanded doesn’t decrease significantly, leading to higher overall revenue.
