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microeconomics > elasticities > Flashcards

elasticities Flashcards

1
Q

what is elasticity

A

measure of responsiveness

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2
Q

what is price elasticity of demand

A

PED measures the responsiveness of demand to a change in price

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3
Q

explain relatively elastic demand

A

%Δ in price will cause a larger %Δ in demand.

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4
Q

explain relatively inelastic demand

A

%Δ in price leads to a relatively smaller %Δ in demand.

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5
Q

what is a perfectly elastic demand

A

%Δ in price leads to an infinite change in demand.
(Demand changes substantially with the most minute change in price)
e.g gold or platinum

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6
Q

what is a perfectly inelastic demand

A

%Δ in price has no effect on the quantity demanded.

(Debatable) Examples include:
Air/Oxygen
Water
Salt

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7
Q

how can price elasticity of demand be calculated

A

% change in the quantity demand / % change in the price of that product

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8
Q

explain the meaning of the different values

A

A value >1 = Relatively elastic
A value <1 = Relatively inelastic
A value of 1 = Unit elastic
(negative value is irrelevant because we are talking about demand. Inverse Relationship.
%change is difference in values/original value x 100)

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9
Q

factors affecting PED-

what does it mean if there are more subsitutes

A
  • The more substitutes that exist, the more elastic demand will be as consumers can switch goods if the price rises. (the higher its PED will be)
  • because consumers can quickly change to other substitute products/brands if there is a small change in the price of that product
    -contrast: products with few or no substitutes have price inelastic demand (e.g. pricate education or prescribed medicine) so small change in price leads to smaller fall in demand as there is less choice

also
Closeness of substitutes is also relevant.
Coke & Pepsi are closer substitutes than Coke and Juice.

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10
Q

how can firms use substitutes to their benefit

A

the number and closeness of firms can be reduced by firms on purpose to increase the opportunity cost of trying to switch to rivarly brands (if high costd are involved in switching then demand will be inelastic)

example- mobile phone subscribers are bound by lengthy contracts so switching between rival services is less easy

customer loyalty programmes also make opportunity cost of switching more difficult- therefore reducing value of PED for firms products

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11
Q

what does the higher the PED value mean

A

it is more elastic

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12
Q

factors affecting PED-
time

A

Over long time period goods become more elastic as consumers find alternatives more easily.
Human nature sticks to what is known. It takes time to change habits. People need time to change their habits and preferences

e.g. diesel fuel is more expensive than leaded fuel, but has greater fuel efficieny (km per litre) but with time, higher tax and price on diesel fuel means increased number of drivers have moved unleaded fuel- over period of time drivers may switch to electric cars as price per km is lower

time is important is consumers want to change purchases or buying habits. the more durable a product (e.g furniture) the more price elastic the demand will be
higher prices of durable products means theres no urgency for consumers to replace existing furniture if prices increased

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13
Q

factors affecting PED- degree of necessity

A

products regarded as essential tend to be price inelastic as theres unlikely to be a big drop in quantity demanded even if prices rise
demand for necessities are relatively unresponsive to change in price

contrast- demand for luxury products are relatively price elastic - they arent necessities so customers can do without them or find cheaper alternatives if price increases (increase in price-decrease in demand)

eval- degree of necessity depends on what is deemed to be necessary for an individual
e.g. if it is an addiction, part of a hobby, - it will be relatively price inelastic bc consumer has little choice but to pay market price

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14
Q

factors influencing PED
- price as a proportion of income

A

the greater the proportion of consumers’ real income is spent on a good or service, the more price elastic the demand will be (ceterus paribus)
- consumers are highly sensitive to changes in the price of products that account for a large proportion of their income
e.g. jewellrey or overseas holidays

contrast- if it only accounts for a small amount of their income, increase in price will have minimal impact of their spending - relatively unreponsive to change in price

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15
Q

what does the value of price elasticity of demand show

A

shows changes in a firms revenue as a result of price changes, depending on whether demand is elastic or inelastic

a firm that has price inelastic demand for its product can increase price to earn more sales revenue

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16
Q

how do u calculate total revenue

A

price x quantity

if a good is price elastic, a firm will be able to increase total revenue by decreasing the price - Lowering the price will lead to enough new customers to make up for it.

if a good is price inelastic, a firm can increase total revenue by increasing price-Price increase is enough to make up for the reduced sales as the good is inelastic.

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17
Q

what is revenue

A

the income that a firm receives from the sale of a good or service to its customers.

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18
Q

what is cross elasticity of demand

XED

A

a measure of how much a price change for one good/service, impacts the demand for another good/service.

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19
Q

how do you calculate XED

A

% change in quantity demanded of product A/ % change in the price of product B

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20
Q

what type of XED do substitute goods have

A

Substitute Goods have a Positive XED
These are goods which ‘compete’ with each other.

If the price of good A goes up, demand for good B will increase.

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21
Q

what type of XED do complementary goods have

A

Complementary Goods have a Negative XED

If the price of good A increases, the demand for good B will decrease.

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22
Q

what type of XED do independent goods have

A

Independent Goods have an XED of 0.
These are goods which have no relation to each other.

If the price of good a increases, there will be 0 impact on the demand for good B.

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23
Q

why can XED be helpful to firms

A

Pricing Policy relative to similar firms
Pricing of complementary goods firms produce

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24
Q

what is YED

A

Income elasticity of demand (YED) is a measure of how much the demand for a product changes following a change in the consumer’s income.

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25
Q

what is the formula for YED

A

% change in quantity demanded/ % change in income

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26
Q

what type of YED do normal goods have

A

Normal Goods have a Positive YED
Demand for these goods increase when consumer incomes increase.

Normal (Necessity) have a positive value but are inelastic (0-1)
Normal (Luxury) have a positive value and are elastic (>1)

If income increases you will only buy marginally more of basic items e.g. bread (low elasticity) but if income increases purchase of luxuries (jewelry, sports cars) increases a lot this is a luxury good.

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27
Q

what type of YED do inferior goods have

A

Inferior Goods have a Negative YED
These are goods which as income increases, quantity demanded decreases.

w,g,Economy class air travel, budget supermarkets

because the demand decreases as income increases. People start to switch their
expenditure from the inferior goods that they had been buying to superior goods, which they can now afford. For example, the demand for inexpensive jeans falls as income rises because people switch to buying branded jeans

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28
Q

why is YED important to firms

A

Sales Forecasting (Economic Cycle) (the process of estimating future revenue by predicting how much of a product or service will sell)

Diversification*
Various goods and services at different price points will spread risks if income varies.

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29
Q

what does the engel curve show

A

relationship between income and the demand for a product over time.

Once income gets to a certain level, demand for normal goods will level out.

At a higher income level, the good will be substituted for a ‘Superior’ good.

30
Q

why do superior goods have high income elasticity

A

The demand for them changes significantly if income rises. As people have more income and have satisfied their needs, they begin to purchase products that are wants, i.e. non-essential, in greater number. For example, the demand for holidays in foreign countries is likely to be income-elastic

31
Q

why do necessity goods have low income elasticity

A

The demand for them will change very little if income rises. For example, the demand for bread does not increase significantly as income rises, because people feel that they already have enough bread and so will not increase consumption

32
Q

what is price elasticity of supply

A

Price elasticity of Supply (PES) is a numerical measure of the responsiveness of the quantity Supplied following a change in the price of that product.

33
Q

how to calculate price elasticity of supply

A

Percentage change in quantity supplied of the product
_____________________________________
Percentage change in price of the product

34
Q

what is relatively elastic supply

A

A %Δ in price will cause a proportionately larger %Δ in supply

35
Q

what is relatively inelastic supply

A

A %Δ in price leads to a proportionately smaller %Δ in supply.

36
Q

what is perfectly elastic/ inelastic supply

A

Perfectly Elastic Supply (E)
A change in price leads to an infinite change in supply.

Perfectly Inelastic Supply (A)
Change in price leads to no change in Supply.

37
Q

what do the values of PES tell us

A

A value >1 = Relatively elastic
A value <1 = Relatively inelastic
A value of 1 = Unit elastic

38
Q

how does the existence of unusued capacity influence PES

A

if a firm has a lot of unused capacity (e,g, if significant resources are not being fully used, output is increased without great cost increases)- elasticity of the product will be high

if a firm is producing at a capacity where it is difficult to increase supply without an increase in resources, it will be expensive so firms cannot increase supply and PES is relatively inelastic

39
Q

how does the mobility of the factors of production influence PES

A

if factors of production are quickly moved from one to another. PES is relatively elastic e.g. it is easy to shift production of manufacturing one to manufacturing two but the extra cost of switching will cause a change to take place

40
Q

how does the time period influence factors of production (influence PES)

A

the amount of time that PES is measured over will affects its value- the longer the time period that is considered, the more elastic the supply will be

e.g. in an immediate time period, firms cannot increase their supply as much since they cannot increase the factors of production that they want to employ immediately (PES is inelastic)

in short run, firms can increase some quantity of factors they employ e.g raw materials and labour but cannot increase all factors e.g. machines (pes is more elastic compared to immediate time period)

long run- firms can increase quantity of all factors that they employ (value of PES is more elastic)

41
Q

how does ability to store stock influence PES

A

if a firm is able to store high levels of stock of their product, they will be able to react price increase with a swift supply increases- PES is relatively elastic

42
Q

explain inelastic supply with PES

A

If factor costs rise exponentially as output increases, then firms are unlikely to increase supply. - Inelastic Supply

43
Q

explain elastic supply with PES

A

If factor costs do not rise a lot as output is increases, then firms will attempt to increase supply when price rises. - Elastic Supply

44
Q

explain the effect of spare capacity on PES

A

Spare capacity means that there are extra factors of production that can be used if necessary.

If there is a price rise, a firm can increase supply easily/cheaply as factor costs will not increase a lot. - Elastic

E.g. Opec Members & Oil pumps* or Housebuilders

Unused capacity can mean machines are not being used, people are not working for long periods of time etc.
*specifically only opec members, other countries will have difficulty increasing supply

45
Q

explain effect of barriers to market entry on PES

A

If it is difficult for new firms to enter the market then supply will not be able to respond to price changes. - Inelastic Supply

Few Barriers will mean more firms are able to enter the market.

E.g. Commercial Airlines

46
Q

explain effect of factor mobility on PES

A

If firms are able to move/reposition their FOP to produce another good process, this will help them have a more elastic supply, meaning they can adjust much quicker to price changes.

Examples:
Wheat to Corn
Covid-19 LVMH Perfume to Hand Gel.

47
Q

explain the effect of storage ability on PES

A

If firms can physically store goods it is easier to react to price changes and increase supply to the market. - Price Elastic Supply

E.g. Small manufactured goods can usually be stored for long periods of time.

e.g. agricultural goods cannot be stored for a long time

48
Q

explain the effect of time on PES

A

The longer the time period considered the more elastic supply will be as it is easier to increase production.

Immediate: Perfectly Inelastic
Short-Run: Inelastic
Long-Run: Elastic

49
Q

what is minimum pricing

A

Also known as a ‘Price Floor’
A form of Government Intervention where a legal minimum price for a good/service is set.

50
Q

what are reasons for a price floor

A

Tackling Negative Externalities- Minimum prices try to reduce their consumption. Consumers have too little info on bad goods

Reduce Poverty & Inequality- Minimum price for labour protects the poorest;

Stabilise Income & Reduce Volatile Prices- Stabilise farmer income as agricultural product are volatile but nationally important.

Tackling Information Gaps

51
Q

what are issues with minimum price

A

Rise of Black Markets & Smuggling
Regressive- larger impact onthe poor
Depends on PED
Government must ‘buy’ excess supply
Not allocatively efficient outcome.
wasted resources disposed in landfill
illicit production - to produce illegally
inefficient allocation of resources

52
Q

impacts of minium price

A

consumers lose more as there is anhigher price so there are using more of their disposable income

producers are winning as they have greater supply so a greater profit- higher revenue

workers are working longer - more employment so higher salaries

government- less NHS referrals which are publicly funding so less government spending

but more disposal of excess supply

53
Q

what is maximum price

A

Also known as a ‘Price Ceiling’.

A form of Government Intervention where a legal maximum price for a good/service is set.

54
Q

reasons for maximum price

A

Encourage Consumption of merit goods
Protect Consumers/Vulnerable
Reduce Inequality

Consumers especially need to be protected from godos that are inelastic as there may be sharp price rises.

55
Q

how has maximum price been applied in real life

A

-EU roaming data cap (£42)
- energy price cap (£1950)
-Rent control prices can only be increased by 7.5% over two years max

56
Q

why is there a decrease in supply when maximum price is set

A

Suppliers are no longer incentivised by the low price and supply contracts

57
Q

what are issues with maximum pricing

A
  • inefficient allocation of resources as there is less demand
  • illicit production- black markets- less tax revenue, risking health and safety
  • unintended consequenes e.g. bribery
58
Q

explain arab opec embargo 1973

A

price cap on $1 placed on per gallon of fuel which led to a large shortage as there was excess demand
evidence- there was more queues for lines of fuel

59
Q

impact of maximum price on different groups

A

some consumers will benefit if they can access the good they want despite the shortage
some consumers will lose out if they are unable to get the good

firms lose profit- as there is a maximum price they lose revenue so theyre less incentivised to join the market

workers lose out alongside firms

government- less tax, they gain in popularirtye.g. politican popularity

60
Q

what is common agricultural policy

A

EU policy to provide financial support to farmers in member states and ensure food security.

Clear example of Minimum Pricing.

Produce in different sectors are guaranteed to be bought by the European Union

61
Q

what are problems with common agricultural policy

A

Accounts for 45% of European Union Budget.
Unintended Consequences (Environment)
Excess Supply
For example:
Milk lakes & Butter Mountains
France destroying excess wine

62
Q

what is indirect taxation

A

Taxes on goods and services that are paid to the government by producers/firms.

Indirect Taxes exist to:
Generate Revenue
Prevent overconsumption of demerit goods
Redistribute Wealth

63
Q

what is specific tax

A

fixed taxes per unit
e.g. sugar tax - 24p per litre

Examples include:
Soft Drink Industry Levy (Sugar Tax)
Tobacco Duties

64
Q

proportional tax

A

All who have to pay have the same rate of tax

65
Q

Progressive tax

A

Those with higher incomes pay a higher rate of tax
Progressive equals income tax, Proportional would equal a tax where everyone has to pay 5%

66
Q

Regressive tax

A

Those on lower incomes pay a higher rate of tax
Regressive equals VAT, Congestion Charge

67
Q

What is an Ad Valorem Tax?

A

A flexible tax which is depends on the value of the asset or the price of the good
Examples include:
VAT/Sales Tax
Stamp Duty

68
Q

subsidies

A

Subsidies are financial assistance given by the government to individuals or groups (Industries, firms, organizations).

69
Q

what can subsidies be

A

May be a cash payment*
May be an interest Fee Loan
Tax Relief/Breaks
Exemptions on Rent

70
Q

why are subsidies used

A

Reduce the cost of training new workers
Protect jobs in loss making but vital sectors
Protect Jobs in a recession
Fund Innovation & growth
Improve housing and transport affordability
Increase output of merit goods
Encourage the arts & culture sectors

71
Q

aim of subsidies

A

Subsidies to producers reduce their costs of production, which then allows firms to increase supply of goods/services.

72
Q

what is common agricultural policy

A

EU Initiative provides government subsidies to farmers in order to increase their output.

37.8bn Euros were provided to EU Farmers in 2021.

microeconomics (10 decks)

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