Elasticity Flashcards
What is price elasticity of demand(PED)?
Responsiveness of the quantity of a good demanded to changes in its price
What is the equation for PED?
% change in quantity demanded of the product/% change in price of the product
What happens if PED is zero?
The change in price will have no effect of Qd so it will be perfectly inelastic
What happens if PED is infinity?
Any price rise above P1 will reduce demand to zero. This is said to be perfectly elastic
What does it mean if the value of PED is less than one and greater than zero?
Inelastic demand
What does it mean if PED is equal to 1?
A product has unit elastic demand
What are determinants of PED?
- Number and closeness of substitutes
- Necessities vs luxuries
- Proportion of income spent on a good
What is the income elasticity of demand?(YED)
A measure of how much the demand for a product changes when there is a change in the consumer’s income
What is the equation for YED?
% change in quantity demanded of the product/ % change in income of the consumer
What is a normal good?
A product for which demand rises as income rises
What is an inferior good?
A product for which demand falls as income rises
What is the value of YED for normal and inferior goods?
Normal goods- positive
Inferior goods- negative
What is the type of good if the YED value is less than one and what is the meaning?
An inferior good. A given increase in income will lead to a proportionally smaller fall in demand
What is the type of good if the YED value is more than one and what is the meaning?
It is a luxury.
A given increase in income will lead to a proportionally larger increase in demand
What is the type of good if the YED value is less than one and greater than zero and what is the meaning?
It is a necessity. A given increase in income will lead to a proportionally smaller increase in demand
What is the price elasticity of supply? (PES)
A measure of the responsiveness of quantity supplied to changes in price
How do you calculate PES?
% change in quantity supplied/ % change in price
What determines PES?
- How much costs rise as output increases
- existence of unused capacity
- mobility of factors of production - Ability to store stock
- The time period considered
What happens when demand is elastic to total revenue?
An increase in price causes a fall in total revenue while a decrease in price causes a rise in total revenue.
What happens when demand is inelastic to the total revenue?
An increase in price causes an increase in TR while a decrease in price causes a fall in total revenue.
Explain the concept of elasticity
A concept used to measure the change in the quantity demanded of a good or service in relation to price movements of that good or service
What is the importance of PED for firms?
Allows them to predict the direction of change of their revenues given a price change
Helps them to determine the extent to which they can shift an indirect tax on to the consumer
What is the importance of PED for governments?
Helps governments interested on increasing their tax revenues to decide on which goods to impose an indirect tax
Allows governments to estimate the size of the necessary tax required to decrease consumption of demerit goods
