Elasticities Flashcards
Define Price Elasticity of Demand
The responsiveness of quantity demanded to a change in price
How is it calculated
PED = % change in quantity demanded / % change in price
If PED is between (-1, - infinity) , what does this suggest about price elasticity of demand?
The good is very price elastic - a small change in price dramatically reduces demand
If PED is between (-1, 0), what does this indicate about the good?
The good is price inelastic - quantity demanded reduces by disproportionately less than the increase in price, meaning that revenue increases.
What are the 6 main determinants of PED
Substitutes, Necessities, Time, Addictiveness, proportion of income spent, definition of the market
Explain how substitutes for a good affects its PED
If a good has many close substitutes, then the good will be price elastic. Quantity demanded will be very responsive to changes in price because if the firm decides to raise the price of the good, its demand will decrease dramatically as consumers will quickly switch to cheaper close substitutes.
Explain how proportion of one’s income spent affects its PED for a good
The greater the proportion of income spent on the good, the more price elastic the good will be. This is because even if the price of a CHEAP good increases by 30%, people will still be willing and able to buy it. In contrast, if the price of a car went up 30%, people will reconsider.
Explain how time affects PED for a good
In the short run, the good you are looking at might be the only available option, therefore PED is more inelastic
In the Long run, you can shop around, so the good will be more price elastic
Define YED
Income elasticity of demand - the responsiveness of demand to a change in income.
What is the formula for YED?
YED = % change in QD / % change in income
If YED is positive, what does this say about income and the type of good
As real incomes rise, quantity demanded for this good will increase
Normal good
If YED is negative, what does this say about income and the type of good
As real income rises, the quantity demanded for this good falls
Inferior good
If YED is positive and >1, what does this say about income and the type of good
As income rises, quantity demanded increases by more than the rise in real income
Luxury good
If YED is positive and <1, what does this say about income and the type of good
As income rises, quantity demanded increases by less than the rise in real income
Necessity
Define XED
Cross - Elasticity of Demand - responsiveness in demand for one good to a change in price of another
XED formula
XED = %∆ quantity demanded of good x / %∆ in price of good y
If the XED coefficient is between -1<x<1, what does this suggest about the two goods
The goods are cross price inelastic
Demand for good X changes by less than the change in price of the good Y
If the XED coefficient is between x<-1 and x>1, what does this suggest about the two goods
The goods are cross price elastic
Demand for good x changes by more than the change in price of good Y
If the goods are complements, what can we infer about their XED?
- It will be negative
- An increase in price of good Y will lead to decrease in demand for its complement, causing XED to be negative
If the goods are substitutes, what can we infer about their XED?
- It will be positive
- An increase in price of good Y will mean that demand for its cheaper substitutes, will increase.
Define PES
PES - the responsiveness of supply to a change in price
Formula of PES
PES = %∆ quantity supplied / %∆ price
What can we infer if a good’s PES is between 0<x<1?
Price inelastic
If the price rises, firms will increase the supply but by less than the increase in price
What can we infer if a good’s PES is greater than 1
The good is price elastic
As price rises, firms are willing and able to supply disproportionately more than the change in price
What are the key determinants of supply?
- Stocks,
- Spare capacity
- Availability and cost of switching from one resource to another
- Time
Explain the determinants of elasticity of supply
Stocks
If stocks of finished goods are available, then supply will be relatively elastic because manufacturers will be able to respond disproportionately to a price change
Spare Capacity
If a firm is operating below its full capacity, it has underutilised machinery and underemployed workers, then supply is likely to be price elastic
Availability and cost of switching from one resource to another
If workers need very specific skills, or if machinery is highly specialised, then supply is likely to be more inelastic because, for a change in price, the firm won’t be able to increase the quantity supplied
Time
In the short run supply is likely to be more inelastic because producers find it difficult to increase production
In the long run, supply will be more price elastic because producers can adjust to changing market conditions by buying more machinery and storing spare stock, predicting future demand etc.
Explain, with the aid of a diagram, why price elasticity of demand changes along a
downward sloping straight-line demand curve. [10]
(b) Evaluate the extent to which knowledge of price elasticity of demand is important for
decision making by firms and governments. Use diagrams to illustrate your answer. (20)
10 marker in green book
