elasticity Flashcards
elasticity
how responsive the demand/supply is to a change in price
price elasticity of demand
PED
the responsiveness of a change in demand to a change in price
PED formula
%change in quantity demanded/
%change in price
a price elastic good
- is very responsive to a change in price.
- the change in price leads to an even bigger change in demand.
numerical value for a price elastic good
PED is >1
a price inelastic good
has a demand that is relatively unresponsive to a change in price
numerical value for a price inelastic good
PED is <1
a unitary elastic good
has a change in demand which is equal to the change in price
numerical value for a unitary elastic good
PED= 1
a perfectly inelastic good
has a demand which does not change when price changes
numerical value of a perfectly inelastic good
PED=0
a perfectly elastic good
has a demand which falls to zero when price changes
numerical value of a perfectly elastic good
PED= infinity
elasticity of demand and tax revenue
the burden of an indirect tax will fall differently on consumers and firms, depending on if the good has an elastic or inelastic demand.
which curve do the taxes shift
elasticity of demand & tax rev
shifts the supply curve, not the demand curve
inelastic demand & tax revenue
- if a firm sells a good with an inelastic demand, they are likely to put most of the tax burden on the consumer, because they know a price increase will not cause demand to fall significantly.
inelastic demand & tax revenue
diagram
an increase in tax will decrease supply from S1 to S3, which increases price from P1 to P3, and therefore demand contracts from Q1 to Q3.
this is the most effective for raising government revenue
elastic demand & tax revenue
- if a firm sells a good with an elastic demand, they are likely to take most of the tax burden upon themselves. this is because they know if the price of the good increases, demand is likely to fall, which will lower their overall revenue.
is it effective for raising government revenue?
elastic demand & tax revenue
not as effective, but if a government wants to reduce the demand of a particular good, it is effective.
demand will fall significantly, from Q1 to Q2.
elasticity of demand and subsidies
it has the opposite effect of a tax because it increases supply. the benefit of the subsidy can go to both the producer, in the form of increased revenue (c-p1), or to the consumer, in the form of lower prices (p1-p2)
subsidy
a subsidy is a payment from the government to firms to encourage the production of a good and to lower their average costs.
PED and total revenue formula
-total revenue= average price x quantity sold
TR=PxQ
PED and total revenue
inelastic demand
the firm can raise its price, and quantity sold will not fall significantly. this will increase total revenue
PED and total revenue
elastic demand
if the firm raises its price, quantity sold will fall. this will reduce total revenue
income elasticity of demand
is the responsiveness of a change in demand to a change in income
formula for income elasticity of demand
YED= %change in quantity demanded/
%change in income
inferior good
are those which see a fall in demand as income increases.
for example, the value options at supermarkets could be seen as inferior.
as income increases, consumers switch to branded goods.
YED <0
examples of inferior goods
cheap substitutes
-smart price tinned beans, instant noodles
normal good
demand increases as income increases.
YED >0
examples of normal goods
- steak
- laptop
- housing
luxury good
an increase in income causes an even bigger increase in demand.
YED >1
example of luxury goods
- holidays
- high end electronics
- luxury goods are also normal goods and they have an elastic income
cross elasticity of demand
is the responsiveness of a change in demand of one good, X, to a change in price of another good, Y.
cross elasticity of demand
XED= % change in quantity demanded of X/
% change in price of Y
complementary goods & XED
- product/service that adds value to another. in other words they are two goods that consumers use together.
- for example, cereal and milk, DVD and DVD player
- have a negative XED. if one good becomes more expensive, the QD for both goods will fall.
close complements
XED
a small fall in the price of good X leads to a large increase in QD of Y
weak complements
XED
a large fall in the price of good X leads to only a small increase in QD of Y
substitute goods & XED
- two alternatives that could be used for the same purpose.
-for example, coke & pepsi, tea & coffee.
-as they can replace another good, the XED is positive and the demand curve is upward sloping.
if the price of one brand of TV increases, consumers might switch to another brand
close substitute
XED
a small increase in the price of good X leads to a large increase in QD of Y
weak substitute
XED
a large increase in the price of good X leads to a smaller increase in QD of Y
unrelated goods & XED
XED= 0
for example, the price of a bus journey has no effect on the demand for tables
firms & XED
firms are interested in XED because it allows them to see how many competitors they have. therefore they are less likely to be affected by price changes by other firms, if they are selling complementary/ substitue goods
the incidence of tax and effects of subsidies on PED>1
the incidence of the tax will fall mainly on the supplier
the incidence of tax and effects of subsidies on PED<1
the incidence of the tax will fall mainly on the consumer
price inelastic demand and subsidies
if demand is price inelastic, the subsidy will have a large effect on equilibrium price.
this gives a greater consumer gain than when demand is elastic
price elastic demand and subsidies
if demand is price elastic, the subsidy will have a large effect on quantity and therefore benefit producers more.
price elasticity of supply
the responsiveness of a change in supply to a change in price.
price elasticity of supply formula
PES= % change in QS/
% change in price
elastic supply
if supply is elastic, firms can increase supply quickly at little cost.
the numerical value price elastic supply
PES >1
inelastic supply
if supply is inelastic, an increase in supply will be expensive for firms and take a long time
the numerical value for price inelastic supply
PES <1
perfectly inelastic supply
supply is fixed, so if there is a change in demand, it cannot be met easily
the numerical value for a perfectly inelastic supply
PES=0
perfectly elastic supply
any quantity demanded can be met without changing price
the numerical value for a perfectly elastic supply
PES= infinity
factors influencing PED
- necessity
- substitutes
- addictiveness or habitual consumption
- proportion of income spent on the good
- durability of the good
- peak and off-peak demand
necessity
factor influencing PED
a necessary good, such as bread/electricity, will have a relatively inelastic demand.
so even if prices increase significantly, consumers will still demand these goods, because they need it.
substitutes
factor influencing PED
-if the good has multiple substitutes, demand is more price elastic.
-the elasticity can also change within markets. the closer and more available the substitutes are, the more price elastic the demand.
-elasticity also changes in the long and short run:
long run- consumers have time to respond and find a substitute, so demand becomes more price elastic
short run- consumers do not have this time, so demand is more inelastic
addictiveness/habitual consumption
factor influencing PED
the demand for goods such as cigarettes is not sensitive to a change in price because consumers become addicted to them, and therefore continue demanding the cigarettes, even if the price increases.
proportion of income spent on the good
factor influencing PED
- if the good only takes up a small proportion of income, such as a magazine which increases in price from £1.50- £2, demand will be price inelastic.
- if the good takes up a significant proportion of income, such as a car which increases in price from £15,000- £20,000, the demand is likely to be price elastic
durability of the good
factor influencing PED
a good which lasts a long time, such as a washing machine, has a more elastic demand because consumers wait to buy another one
peak and off peak demand
factor influencing PED
during peak times, such as 9am and 5pm for trains, the demand for tickets is more price inelastic.
factors affecting YED
- the nature of the good will determine the income elasticity of demand; i.e whether it is inferior, normal or luxury
- other factors; the versatillity of the good( consumers may be more likely to continue purchasing the good after an income change if the good has multiple purposes) and time, as some new goods may need time to gain attention in the market despite changes in consumer incomes.
factors affecting XED
the type of good will affect cross price elasticity, since a complement would give a negative XED, a substitute would give a positive XED and an unrelated good would have no impact on the XED
factors influencing PES
- time scale
- spare capacity
- level of stocks
- how substitutable factors are
- barriers to enter the market
time scale
factors influencing PES
in the short run, supply is more price inelastic, as producers cannot quickly increase supply.
in the long run, supply becomes more price elastic
spare capacity
factors influencing PES
if the firm is operating at full capacity, there is no space left to increase supply. if there are spare resources, for example in a recession there are lots of spare and unemployed resources, supply can be increased quickly.
level of stock
factors influencing PES
if goods can be stored, such as CDs, firms can stock them and increase market supply easily.
if the goods are perishable, such as apples, firms cannot stock them for long so supply is more inelastic
how substitutable factors are
factors influencing PES
if labour ad capital are mobile, supply is more price elastic, as resources can be allocated to where extra supply is needed. for example, if workers have transferable skills, they can be reallocated
to produce a different good and increase the supply of it
barriers to enter the market
factors influencing PES
higher barriers to entry means supply is more price inelastic, because it is difficult for new firms to enter and supply the market
