Elasticity Flashcards
Define price elasticity of demand (PED)
The responsiveness of quantity demanded for a product to a change in its price
Define income elasticity of demand (YED)
The responsiveness of quantity demanded for a product to changes in consumer incomes
Define cross price elasticity of demand (XED)
The responsiveness of quantity demanded for a product to changes in the price of another product
Define price elasticity of supply (PES)
The responsiveness of quantity supplied for a product to a change in its price
How to workout PED
% change in Qd divided by % change in P
How to work out % change
New - old
————— x 100
Old
Interpretation of the sign of PED
Is always negative as numerator and denominator will always have different signs, represents the negative relationship between P and Qd, when P rises Qd will fall and vica versa
Interpretation of magnitude for PED, YED, XED, PES
Represents how responsive Qd is to P changes 0 = perfectly inelastic 1 = unitary elasticity Infinity = perfectly elastic 0 to 1 = inelastic 1 to infinity = elastic
What are the determinants of PED
Number and availability of substitutes Proportion of income spent on the product The degree of habit Necessity or luxury The time period
How to work out YED
% change in Qd
________________
% change in Y
Interpretation of the sign of YED
YED positive = normal goods
YED negative = inferior goods
How to work out XED
% change in Qd of good A
___________________________
% change in P of good B
Interpretation of sign of XED
XED is positive = substitutes
XED is negative = compliments
Define total revenue
The income a firm receives from selling its good or service
How to work out total revenue
Total revenue = price x quantity sold
How to work out PES
% change in Qs
________________
% change in P
Interpretation of sign of PES
Always positive
What are the determinants of PES
Time
Availability of stock
Factor mobility
Availability of the FOP
What to do to increase revenue when PED is inelastic
Increase price to increase total revenue, overall revenue rises
What to do to increase revenue when PED is elastic
Decrease price to increase total revenue, overall revenue rises
How to work out profit
Profit = total revenue - total costs
What to do when PED is unitary to increase D
Keep price unchanged and use other marketing techniques such as advertising in order to shift the demand curve to the right
Limitations of this analysis
Only applies to small changes in price
Only applies if the firms objective is to increase revenue
Assumes ceteris paribus
How to use YED
Used to predict income of a firm
Used to understand the target market of a product
Using XED to determine a firm’s marketing strategies
If XED is high ( elastic ) negative, would suggest a close complementary relationship so firm would want to avoid increasing P as it could significantly effect D for compliments
If XED is a high ( elastic ) positive, this would suggest a close substitute, if this is with a competitor’s product then it may suggest price cuts would be very effective if advertised to the competitor’s consumers
General limitations of using any elasticity figure
Elasticity figure are likely to be estimates
Past data from firms can often be inaccurate as current and future market conditions are not necessarily the same as the past and elasticity can change over time - ceteris paribus doesn’t hold in the real world.
