Elasticities of Demand Flashcards
What is elasticity?
A measure of how responsive something is in response to a change in a given factor.
What is price elasticity of demand (PED)?
A measure of how responsive the quantity demanded for a good or service is in response to a change in price of given good or service.
What does PED stand for?
Price elasticity of demand.
What is the formula for PED?
PED = %change in quantity demanded / %change in price
What is perfectly inelastic demand?
Quantity demanded does not change as price rises.
What is inelastic demand?
Quantity demanded changes by a smaller percentage than price changes.
What is unitary elastic demand?
Quantity demanded changes by the same percentage as a change in price.
What is elastic demand?
Quantity demanded changes by a greater percentage than a change in price.
What is perfectly elastic demand?
Buyers will purchase all they can at a given price, but none at a higher price.
What is the numerical representation of perfectly inelastic demand?
Zero (0).
What is the numerical representation of inelastic demand?
Between zero and one ( 0<PED<1).
What is the numerical representation of unitary elastic demand?
One (1).
What is the numerical representation of elastic demand?
Between 1 and infinity (1<PED<∞).
What is the numerical representation of perfectly elastic demand?
Infinity (∞).
What is the graphical representation of perfectly inelastic demand?
A vertical line.
What is the graphical representation of inelastic demand?
A steep line.
What is the graphical representation of unitary elastic demand?
A diagonal line.
What is the graphical representation of elastic demand?
A shallow line.
What is the graphical representation of perfectly elastic demand?
A horizontal line.
What are the determinants of PED (2)?
1) The availability of substitutes.
2) Time.
How does time influence PED?
If the price of petrol (inelastic good) rose, there would be little impact on demand. However, over time, alternative means of travel will be discovered (walking, cycling, etc.) and demand would fall.
How does the availability of substitutes influence PED?
The greater the quality and availability of substitutes that a good has, the higher its elasticity. E.g. sweets have many substitutes (wine gums, Haribo, Maoams, etc.) so they are relatively elastic. In contrast, salt has no substitutes, so is relatively inelastic.
What is income elasticity of demand?
A measure of the sensitivity of the quantity demanded for a certain good or service in response to a change in real income.
What is YED?
Income elasticity of demand.
What is the formula for YED?
YED = %change in quantity demanded / %change in income
What is cross-elasticity of demand?
A measure of the responsiveness in the quantity demanded of one good in response to a change in the price of another good.
What is CED?
Cross-elasticity of demand.
What is the formula for CED?
CED = %change in quantity demanded for good X / %change in price of good Y
What are the 6 different types of goods?
1) Normal goods.
2) Inferior goods.
3) Complementary goods.
4) Substitute goods.
5) Luxury goods.
6) Necessity goods.
What is a normal good?
A good that sees an increase in demand as incomes rise (and vice versa). E.g. food, clothing and household appliances.
What is an inferior good?
A good that sees a fall in demand as incomes rise (and vice versa). E.g. ready meals, frozen foods and used cars.
What is a complementary good?
A good that is typically brought alongside another. Complementary goods will always have a negative CED. E.g. cereal and milk, bread and butter, smartphones and phone cases, etc.
What is a substitute good?
A good which can be replaced by another good, perhaps due to a rise in price. Substitutes will always have a positive CED. E.g. butter and margarine, Coca Cola and Pepsi, similar holiday destinations, etc.
What is a luxury good?
A good for which demand increases more than proportionally as income rises. E.g. designer clothing, premium watches and high end cars.
What are necessity goods?
Products and services that consumers will buy regardless of changes in their income levels. E.g. haircuts, water and electricity.
At what value of PED is total revenue maximised?
PED = +/- 1, when PED is unitary.
What is the formula for revenue?
Revenue = selling price x quantity sold
If PED is inelastic, what will happen to revenue when prices rise and fall?
1) When prices rise, so will total revenue.
2) When prices fall, so will total revenue.
If PED is unitary, what will happen to revenues when prices rise and fall?
1) When prices rise, total revenue will be unchanged.
2) When prices fall, total revenue will be unchanged.
If PED is elastic, what will happen to revenue when prices rise and fall?
1) When prices rise, total revenue falls.
2) When prices fall, total revenue rises.
How can knowledge of YED be useful to firms (2)?
1) Information about YED can be used for sales forecasting.
2) Information about YED can be used to decide which product is best to sell depending on the economic climate. E.g. in a boom, firms may choose to sell a product with a high YED.
How can knowledge of CED be useful to firms?
Understanding of CED can help firms to monitor price changes in substitute and complementary goods in order to adjust their own prices accordingly.
