Elasticity Flashcards
What is Price elasticity of demand (PED)?
It measures the responsiveness in quantity demanded to a change in price.
How do we measure PED?
% Change in quantity demanded / % Change in price alternatively
^ QD/^P x P/QD
What is inelastic PED?
It reflects a situation in which the percentage change in quantity demanded is smaller than the percentage change in price. The demand curve is more sloped towards the price axis. The PED is 0 < PED > 1
What is elastic PED?
It is a situation in which the percentage change in quantity demanded is greater than the percentage change in price. The demand curve is more sloped towards the quantity axis. The PED is 1 < PED > infinity
What is unitary PED?
The % change in quantity demanded is the same as the % change in price. The demand curve takes the slope of a rectangular hyperbola.
What is perfectly elastic PED?
At a given price any quantity is demanded, however at a slightly higher price demand is 0, and at a lower price demand is infinite. The demand curve is parallel to the quantity axis. The PED is inifnite.
What is perfectly inelastic PED?
Irrespective of the price change, the qd remains the same. The demand curve is parallel to the price axis. The PED is 0.
What are the factors that determine the price elasticity of demand?
- The nature of goods
- Availability of substitutes
- Fraction of income spent
- Durability/ consumers ability to delay the purchase
What are the points of elasticity on a linear demand curve?
At a point where the demand curve intersects the vertical axis, PED is elastic/infinite.
At a point where the demand curve touches the X axis, PED is 0.
In the middle of the demand curve, PED = 1
Any point above the mid point, PED is elastic, any point below 1 is inelastic.
How is total revenue demonstrated using a demand and supply curve graph?
It is the square area below the price line. P x Q
What is the effect of a price increase of an inelastic good on seller’s income?
It will increase the producer’s income as consumers have no choice but to purchase the product and vice versa.
What is the effect of a price fall of a good with elastic demand on producer’s income?
The revenue will rise, as a price fall will encourage consumers to purchase more.
What is the nature of total revenue on a product with unitary PED?
The percentage % increase or decrease in price has no impact on the seller’s income. It remains unchanged. This is because QD changes by the same proportion as the price changes.
What is the nature of total revenue on a product with perfectly elastic PED.
A price increase will decline income to 0 and a price fall is equal to infinite income.
What is the nature of total revenue on a product with perfectly inelastic PED.
When the price falls, income will fall. When the price rises income will increase.,
What are the advantages of PED?
-It can be used to determine the pricing policy.
- It is used by the government to estimate the impact of a rise in indirect tax on sales and tax revenue.
If the government wants to increase tax revenue by charging indirect tax it can only do so with goods that have an inelastic demand. The producer can decide the tax burden the consumer will bear and the producer will bear.
- Government can determine how the benefit of a subsidy will be shared between the consumer and the producer.
What are the disadvantages of PED?
- Calculations are based on estimates and can be inaccurate.
-PED can change according to economic changes, so it has little use of it.
What are a few laws to remember about the relationship between consumer surplus and PED?
- When the demand for a good is perfectly elastic, consumer surplus is 0, because the price that they pay matches what they are willing to pay. You’ll see that in a perfectly elastic demand graph, there is no common area to shade that is above the price line and below the demand curve.
- When demand is perfectly inelastic, consumer surplus is infinite. Demand does not respond to a price change.
What is the nature of the income spent on elastic goods?
A higher proportion of income will be spent on elastic goods. Thus making consumers more price-sensitive to these productsts and therefor making it elastic.
What is the nature of the income spent on inelastic goods?
A smaller proportion of income will be spent on inelastic goods, as a price change would be insignificant because it only takes up a small proportion of their income.
What is price elasticity of supply (PES)?
It measures the responsiveness of the quantity supplied to a change in price.
How do we measure PES?
% Change in quantity supplied / % Change in price
Alternatively
^ QS / ^ P x P / Qs
What is Inelastic supply?
It occurs when the % change in QS is smaller than the % change in price. The elasticity is 0 > PES < 1. The supply curve starts from the quantity axis and slopes towards the price axis.
What is elastic supply?
The % change in QS is more than the % change in price. The elasticity is 1 > PES < infinity. The supply curve starts from the price axis and is more sloped towards the quantity axis.
What is perfectly inelastic supply?
A change in price has no effect on the Quantity spplied. The supply curve is parallel to the price axis. The elasticity is = 0
What is perfectly elastic supply?
Occurs in markets with high levels of competition.A change in price will cause an infinite change in QS. The supply curve is parallel to the quantity axis.
What is unitary elasticity of supply?
The % change in QS is the same as the % change in price. Supply curve starts at the origin.
What are the factors that determine PES?
The level of stock - If a firm has more stock of goods then supply is likely to be more elastic.
Excess capacity - If capacity to produce is not fully used, supply will be elastic and vice versa.
Time - In the short term supply is likely to be inelastic and vice versa.
Short term - Inelastic
Long term - Elastic
Immediate - Perfectly inelastic
Factor mobility - The easier to move resources, PES is more elastic.
The number of producers - More producers make it easy to increase output to a change in price, therefore making it more elastic.
What are the advantages of PES?
-Firms can use it for planning, by estimating the effect of a price change, and can plan the number of goods to be produced, the number of employees, and the impact on cash flow.
- Used to estimate the impact on consumer spending, producer’s revenue.
What are the disadvantages of PES?
- Calculations based on estimates can be inaccurate
- PES can change according to economic changes
What is income elasticity of demand?
Income elasticity measures the responsiveness of quantity demand to a change in income.
How to calculate the income elasticity of demand?
% change in quantity demanded / % change in income ( y)
alternatively
^ QD / ^ Y X Y / QD
What is positive YED?
This reflects a positive relationship between income and QD. An increase in income will result in an increase in QD and a fall in income results in a fall in QD. This usually exists for luxury goods.
What is negative YED?
It reflects a negative relationship between income and QD. When income increase demand falls, as people move onto better quality products. This exists for inferior goods and giffen goods.
What is Zero YED?
This relationship exists for essential goods. QD remains the same, even when income changes.
What is XED?
It measures the responsiveness in quantity demanded to a change in the price of another product.
When does positive XEd occur?
This relationship exists for substitute goods. If the price of tea increases then demand for coffee may increase.
When does negative XED occur?
This exists for complementary goods. If the price of tea increase, then demand for sugar may fall.
What are the pros of XED?
It helps to know the availability of substitutes and marketing strategies. Suppliers are interdependent therefore there is a danger of rivals cutting prices.
It helps to measure the interdependency of products.
Businesses try to make profits.
Businesses try to make profits.
By ensuring a high level of complementary goods are available at lower prices, this will increase the demand for the main product.
What do PED curves look like?
What do PES curves look like?
