Elasticities Flashcards
What is elasticity?
- How responsive something is to a change in something else
- Measures how easily consumers or producers can change their behaviour
Price elasticity of demand (PED)
Responsiveness of a quantity demanded to a change in price, ceteris paribus
Graph of Elasticities (PED)
Coefficients for PED
PED is negative?
- They are inversely related (e.g. as one goes up, the other goes down)
PED is positive?
- The are positively related. Usually these are exceptions to the law of demand such as Giffen goods or Veblen goods.
/PED/ > 1 = Elastic or relatively elastic
/PED/ < 1 = Inelastic or relatively inelastic
/PED/ = 1 = Unit elastic (proportionally related)
PED = 0 = Perfectly inelastic
PED is infinite = Perfectly elastic
Note: There is no negative PED value, so if it is negative, take the absolute value of it.
Determinants of PED
Substitutes
Proportion of income
Luxury or necessity
Addictiveness
Time to respond
e.g.
high addictiveness = elastic
more substitutes = elastic
high % of income = elastic
luxury = elastic
Income elasticity of demand (YED)
Responsiveness of a quantity demanded to a change in a consumer’s income, ceteris paribus.
Coefficient of YED
YED (+) (normal goods):
- increase in income → increase demand
- fall in income → decrease demand
YED (-) (inferior goods):
- increase in income → decrease demand
- fall in income → increase demand
Importance of YED for explaining changes in the sectoral structure of the economy (HL)
Primary sector - agricultural goods, oil, gas, fruits, vegetables
- YED inelastic
- Exception: diamonds
Secondary sector - manufactured goods, electronics
- YED elastic
Tertiary sector - services like tourism, restaurants, private education/healthcare
- YED elastic
- Exception: education, healthcare, law enforcement
Price elasticity of supply (PES)
Responsiveness of a quantity supplied to a change in price, ceteris paribus.
If PES > 1 Supply elastic (relatively supply elastic)
If PES < 1 Supply inelastic (relatively supply inelastic)
If PES = 1 Unit supply elastic (proportionally related)
If PES = 0 Perfectly Supply inelastic
If PES = infinite Perfectly Supply elastic
Determinants of Supply Elasticity
Time (time to respond to change in price)
Inventory (stocks)
Capacity
Costs (marginal costs)
Substitution of FOP
PED & PES & YED of primary commodities (and agricultural goods/raw materials) vs. manufactured goods (HL)
Price elasticity: Food is essential, making agricultural goods price inelastic.
Supply elasticity: Long production periods make agricultural goods supply inelastic.
Income elasticity: Food spending remains stable as income rises, making agricultural goods income inelastic.
What are the implications of falling agricultural prices in LDCs?
LDCs lack funds for new technology, producing at old efficiency but new prices. Despite higher output, fast price drops reduce incomes.
Revenue boxes: The relationship between PED and total revenue
PES Diagram
Changing PED Along a Linear Demand Curve (HL)
higher prices, lower quantities = elastic
lower prices, higher quantities = inelastic
Why is PED significant for decision making of firms and the government
- adjust prices for which product
- revenue boxes
- burden (tax on diff elasticities)
Why are firms interested in income elasticity? (HL)
What types of goods would firms want to produce in times of recession?
What type of goods would firms want to produce in times of economic boom?
