Elasticities of Supply, Demand

Question 1

Elasticity of demand

Answer 1

Measure of how much the quantity demanded of a product changes when there is a change in one of the factors that determines demand.

We will look at two elasticities of demand: price elasticity of demand (PED) and income elasticity of demand (YED).

Question 2

Price elasticity of demand (PED)

Answer 2

Measures the responsiveness of demand to a change in price (= % change in Qd/% change in P).

The negative value indicates that there is an inverse relationship between price and quantity demanded (but economists give the answer as a positive value for simplicity).

Question 3

Interpreting PED values (after removing the negative) + ranges of elasticity

Answer 3

PED 0 < PED < 1: inelastic (steeper)
- % change in Q < % change in P

1 < PED < ∞: elastic (flatter)
- % change in Q > % change in P

PED = 1: unit elasticity
- % change in Q = % change in P

PED = 0: perfectly inelastic (vertical line)

PED = infinity: perfectly elastic demand
(horizontal line [at exactly that price, consumers will buy any quantity; at a price below, quantity demanded is infinite; above, quantity demanded is zero])

Inelastic Demand:

Percentage change in price is greater than percentage change in quantity demanded: price elasticity of demand is less than one.

Elastic Demand:

Percentage change in quantity demanded is greater than percentage change in price: price elasticity of demand is greater than one.

Question 4

Relationship w/ slope (PED)

Answer 4

Because it measures how much quantity demanded responds to the price, it is closely related to the slope of the demand curve.

Question 5

Elasticity and total revenue (TR)

Answer 5

The amount received by sellers of a good. Computed as the price of the good times the quantity sold (area between origin and endpoint [ykwim]).

If a firm decides to decrease price, the degree of price elasticity of the demand curve would determine the extent of the increase in demand and the change, therefore, in total revenue.

For inelastic goods, an increase in price would lead to an increase in TR (opposite is true for a decrease in price). For elastic goods, a decrease in price would lead to an increase in TR (opposite is true for an increase in price). For goods of unitary elasticity, there’s no change in TR when price is increased/decreased.

Question 6

Determinants of PED

Answer 6

Substitutes
Proportion of income
Luxury or necessity
Addictive or not
Time to respond

Question 7

Why might it be important to know the elasticity of a product if you are a business or the government?

Answer 7

A business can use the information to change prices to increase total revenue (or to avoid making a price change that would decrease total revenue).

A government can use this information in order to raise more tax revenue or influence the demand for a product

Question 8

Income elasticity of demand (YED)

Answer 8

Responsiveness of demand to a change in income (= % change in Qd/% change in Y [income of consumer]).

Question 9

Interpreting YED values

Answer 9

YED < 0: inferior good (a given increase in income will lead to a fall in demand)

0 < YED < 1: normal necessity (a given increase in income will lead to a proportionally smaller increase in demand)

YED > 1: normal luxury (a given increase in income will lead to a proportionally larger increase in demand)

Question 10

Engel Curve

Answer 10

*STUDY ENGEL CURVE

• Perspectives are critical when defining terms
• In highly developed countries, YED for food is 0.2, while in less developed countries it is around 0.8
• What is considered a necessity in one culture or country may be considered a luxury in another (ex. a can of Coke in an affluent neighborhood in Lagos versus a can of Coke in a poor favela in Rio de Janeiro, or a loaf of plan white bread in a poor neighborhood versus the specialty loaf with olives, garlic and sun-dried tomatoes in a rich one)

Question 11

Price elasticity of supply (PES)

Answer 11

Measures the responsiveness of quantity supplied to a change in price (= % change in Qs/% change in P).

Question 12

PES ranges

Answer 12

PES = 0: perfectly inelastic supply
- A change in price will lead to no change in quantity supplied
- Vertical line
- Football match tickets (where a stadium has a maximum capacity), Rembrandt art works, etc.

0 < PES < 1: inelastic supply
- A change in price will lead to a less than proportionate change in quantity supplied
- Steep, intersects x-axis (?)
- Vegetables, commodity agricultural goods, etc.

PES = 1: unit elastic supply
- A change in price will lead to a proportionate change in quantity supplied

PES > 1: elastic supply
- A change in price will lead to a greater than proportionate change in quantity supplied
- Flatter, intersects y-axis (?)
- Face masks, pencils, bread, pizzas, etc.

PES = ∞: perfectly elastic supply
- A slight change in price will lead supply to fall to zero
- Horizontal line
- Largely theoretical (we’ll use it when analyzing global trade)

Question 13

Determinants of PES

Answer 13

Mobility of factors of production
Unused capacity
Time period
Ability to store stock

Question 14

NOTE (PES)

Answer 14

• Supply becomes more elastic over time
• Producers want their supply to be as elastic as possible in order to respond to price changes and make more profit
• Making it easier to hire and fire people can make supply more elastic