Elasticities Flashcards
Elasticity
Responsiveness of one variable to changes in another
Elastic
Change in one produces a larger change in the other
Inelastic
Change in one produces a smaller change in another
Price elasticity of demand?
Responsiveness of the quantity demanded to a change in price
How to calculate PED?
Percentage change in QD/ Percentage change in price
Omit the minus sign always
Perfectly price inelastic demand?
PED = 0
Change in price has no effect on QD
Vertical demand curve
Price inelastic demand
PED > 0 but PED <1
Price causes a less than proportional change in QD
Price elastic demand
PED > 1
Price cases a more than proportionate change in QD
Unit elastic demand
PED =1
Price causes same but opposite % change in QD
Use of PED
Can be used to assess the impact of a price change on total revenue.
Relationship between PED and total revenue
- When demand is price elastic, a fall in price leads to a rise in total revenue.
- When demand is price inelastic, a fall in price leads to a fall in total revenue.
- When demand is unit elastic, total revenue stays the same regardless of price changes.
Determinant of PED
- Availability and closeness of substitutes – more substitutes and closer ones means that demand will be price elastic.
- Marker width -> the narrower the market definition, the more demand will be price elastic.
- The time period -> PED is more inelastic in the short term and elastic in long erm as it takes time for consumers to change their patterns.
- Method of payment e.g. auto added to bill.
- Necessity of the good from consumer perspective -> if it is deemed a necessity then demand will be price inelastic.
- Expense of the good in respect to income: goods which represent a small share tend to have more price inelastic demand.
Income elasticity of demand (YED)
Responsiveness of demand for a good to a change in consumer income
How to calculate YED?
% change in QD/ % change in income
Sign ( + or -) is important
Positive YED
Normal goods > consumer incomes increase, demand increases
Negative YED
Inferior goods > Consumer incomes increase, demand will increase
Normal and inferior goods
A good can be both, it depends on consumer incomes and how people value things
If YED is greater than 1 or less than -1
Demand is income elastic
If YED is between 1 and -1
Demand is income inelastic
Luxury (superior) goods
Usually have a high positive YED (2+)
If YED is = 0
Demand is unresponsive to changes in consumer income
Uses of YED
Gives indication for businesses
High YED = Demand is sensitive = risky to invest
Cross-price elasticity of demand (XED)
Measures the responsiveness of demand for one good to a change in demand for another
How to calculate XED?
% Change in QD for good X/ % Change in price of good Y
If XED = 0 then?
The goods are independent, there is no effect on each other
If XED is positive?
Goods are substitutes, the larger the value the stronger the substitute
If XED is negative?
Goods are complements, the larger the value the stronger the complement
If XED is between +1 and -1
XED is price inelastic
If XED is more than +1 and less than -1?
XED is price elastic
What does XED show?
Impact of your own and competitors price changes on yours and your competitors goods demand and revenue.
If XED is high and positive ?
Price cuts can be used to steal market shares from rival firms, but dangerous if prices are increased.
How can XED give an insight on complementary goods?
Can show the impact of price changes and how to then maximise revenue
Price Elasticity of supply
Measures the responsiveness of quantity supplied to a change in price of a good
How to calculate PES?
% Chane in quantity supplied/ % change in price
PES is always…?
Positive
As price rises, quantity supplied rises as it leads to an increase in profit potential
Perfectly price inelastic supply
PES = 0
Vertical supply curve
Perfectly price elastic supply
PES = Infinity
Horizontal supply curve
Price inelastic supply
PES > 0 but PES < 1
(Change in price creates a less than proportional change in supply)
Price elastic supply
PES > 1
(Change in price creates a more than proportional change in quantity supplied)
Straight line passing through the origin has a PES of …?
1
Unitary price elastic supply
PES =1
(Change in price creates same change in quantity supplied)
(1) Determinants of PES
More substitutes = Higher PES
(2) Determinants of PES
Longer time frame
Price elastic - firms can adjust their resources to change output
Shorter production time means supply will be more price elastic
(3) Determinants of PES
More stock and factors of production available (spare capacity or labour) the more supply will be price elastic
(4) Determinants of PES
More total costs rise, the more supply will be price inelastic
Uses of elasticities
Firms planning or decisions for investment/hiring.
Decision on price strategies – whether to increase or decrease prices.
Competitor pricing decision
Recession means inferior goods booms - Luxury good firms suffer.
Taxation Effects of indirect taxes and subsidies
Changes in exchange rates => The impact of changes in the exchange rate on demand for imports and exports
Government intervention -> may intervene in market by introduction minimum or maximum prices e.g., minimum price for alcohol.
Elasticity of demand supply also affects operation of the price mechanism as a means of rationing scarce goods and services among competing uses and in determining how producers respond to the incentive of a higher market price.
