Elasticity

Question 1

Price Elasticity of Demand

Answer 1

• the degree of sensitivity of consumers to a change in price is measured by price elasticity of demand
• PED is only referred to as an absolute number –> ignore the (-) sign

Question 2

PED formula

Answer 2

Percentage change in the Quantity Demanded / Percentage change in its price

Question 3

Example

Answer 3

$ of CDs increased from 20$ to 22$

The quantity of CDs demanded increased from 100 to 86

(87-100/100) * 100 = - 13.0%

(22-20/20) * 100 = 10%

PED = 13.0/10 –> PED = 1.3

Question 4

E = 1

Answer 4

demand is unit elastic

• consumers’ response and price change are in same proportion
• 45 degrees

Question 5

E < 1

Answer 5

demand is inelastic

• consumers are relatively unresponsive to price changes
• steep gradient

Question 6

E > 1

Answer 6

demand is elastic

• consumers are relatively responsive to price changes
• flat gradient

Question 7

Determinants of PED

Answer 7

1. Number of Substitutes
2. Luxury vs Necessity
3. Price/Income Ration
4. Time Lag

Question 8

1. No. of Substitutes

Answer 8

• if a product can be easily substituted, its demand is elastic –> Gap’s jeans
• if a product cannot be substituted easily, its demand is inelastic –> gasoline

Question 9

2. Luxury vs Necessity

Answer 9

• necessity’s demand is usually inelastic because there are usually very few substitutes for necessities
• luxury products are not needed on a daily basis, meaning there are usually man substitutes for these products –> demand is elastic –> leisure sail boats

Question 10

3. Price/Income Ratio

Answer 10

• the larger the percentage of income spent on a good, the more elastic is its demand
• the smaller the percentage of income spend on a good, the less elastic is its demand
• consumers’ budget with larger magnitude are affected when there is a change to products’ price
• consumers respond by cutting back more on these products when price increases

Question 11

4. Time Lag

Answer 11

• the longer the time after the price change, the more elastic the demand
• consumers are given more time to carry out their actions

Question 12

Elasticity of Supply

Answer 12

According to the LoS:
- the quantity supplied of a particular good or service varies directly with a change in its price

• it measures the responsiveness of the QS to the percentage change in price

Question 13

E > 1

Answer 13

• supply is elastic

- producers are relatively responsive to price changes

Question 14

E = 1

Answer 14

• supply is unit elastic

- producers are relatively unresponsive to price changes

Question 15

E < 1

Answer 15

• supply is inelastic

- producers are relatively unresponsive to price changes

Question 16

E = 0

Answer 16

• supply is perfectly inelastic

- producers are very insensitive to price change

Question 17

1. Product storability and durability

Answer 17

• when items that are durable and stored successfully without deterioration –> a more elastic supply line –> minerals, wheat, wool
• a rise in price -> sellers can quickly and simply access the extra supplies of g/s by reducing their stock of unsold goods
• perishable goods –> less elastic

Question 18

Resource mobility and unused industry capacity

Answer 18

• quantity of a particular item supplied is likely to be more elastic if production levels can be readily and inexpensively change by moving resources between industries
• supply is especially elastic when there is unused or spare productive capacity in an industry or firm

Question 19

The time period

Answer 19

• supply is relatively more inelastic in the short term
• however, in the long term, it is becomes more elastic
• the availability of resources can be increased over a number of years –> supply becomes more responsive to price changes

Question 20

Flat Line vs Steep

Answer 20

Flat => more elastic

Steep => more inelastic