elasticities Flashcards
what is elasticity
measure of responsiveness
what is price elasticity of demand
PED measures the responsiveness of demand to a change in price
explain relatively elastic demand
%Δ in price will cause a larger %Δ in demand.
explain relatively inelastic demand
%Δ in price leads to a relatively smaller %Δ in demand.
what is a perfectly elastic demand
%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
what is a perfectly inelastic demand
%Δ in price has no effect on the quantity demanded.
(Debatable) Examples include:
Air/Oxygen
Water
Salt
how can price elasticity of demand be calculated
% change in the quantity demand / % change in the price of that product
explain the meaning of the different values
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)
factors affecting PED-
what does it mean if there are more subsitutes
- 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.
how can firms use substitutes to their benefit
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
what does the higher the PED value mean
it is more elastic
factors affecting PED-
time
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
factors affecting PED- degree of necessity
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
factors influencing PED
- price as a proportion of income
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
what does the value of price elasticity of demand show
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
how do u calculate total revenue
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.
what is revenue
the income that a firm receives from the sale of a good or service to its customers.
what is cross elasticity of demand
XED
a measure of how much a price change for one good/service, impacts the demand for another good/service.
how do you calculate XED
% change in quantity demanded of product A/ % change in the price of product B
what type of XED do substitute goods have
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.
what type of XED do complementary goods have
Complementary Goods have a Negative XED
If the price of good A increases, the demand for good B will decrease.
what type of XED do independent goods have
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.
why can XED be helpful to firms
Pricing Policy relative to similar firms
Pricing of complementary goods firms produce
what is YED
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.
what is the formula for YED
% change in quantity demanded/ % change in income
what type of YED do normal goods have
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.
what type of YED do inferior goods have
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
why is YED important to firms
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.