Elasticities

Question 1

What is elasticity?

Answer 1

• How responsive something is to a change in something else
• Measures how easily consumers or producers can change their behaviour

Question 2

Price elasticity of demand (PED)

Answer 2

Responsiveness of a quantity demanded to a change in price, ceteris paribus

Question 3

Graph of Elasticities (PED)

Answer 3

Question 4

Coefficients for PED

Answer 4

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.

Question 5

Determinants of Price Elasticity

Answer 5

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

Question 6

Income elasticity of demand (YED)

Answer 6

Responsiveness of a quantity demanded to a change in a consumer’s income, ceteris paribus.

Question 7

Coefficient of YED

Answer 7

Question 8

Importance of YED for explaining changes in the sectoral structure of the economy (HL)

Answer 8

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

Question 9

Price elasticity of supply (PES)

Answer 9

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

Question 10

Determinants of Supply Elasticity

Answer 10

Time (time to respond to change in price)
Inventory (stocks)
Capacity
Costs (marginal costs)
Substitution of FOP

Question 11

PED & PES & YED of primary commodities (and agricultural goods/raw materials) vs. manufactured goods (HL)

Answer 11

Price (demand) elasticity: Food is necessary for survival. As such, agricultural goods are price inelastic.

Supply elasticity: Agricultural goods are supply inelastic. There is a long time period of production for agricultural goods.

Income elasticity: As income increases, the proportion of income spent on food will stay fairly constant. Food and thereby agricultural goods are income inelastic.

Question 12

What are the implications of falling agricultural prices in LDCs?

Answer 12

LDCs don’t have the money for the new technology so working at the old curve but at the new price. Even if they are able to produce more and more of the good, the price is falling so rapidly, their incomes will keep falling (see the revenue boxes).

Question 13

Revenue Boxes (Inelastic vs Elastic)

Answer 13

Question 14

PES Diagram

Answer 14