Elasticity Flashcards
Elasticity
A measure of how much buyers and sellers respond to changes in Market conditions.
Allows us to analyze supply and demand with greater precision.
Price elasticity of demand
Measure of how much the quantity demanded of a good responds to a change in the price of that good.
The % change in QD given a % change in the price
Determinants of price elasticity
- Availability of close substitutes
- Necessities vs luxuries
- Broad vs narrow markets
- Proportion of income devoted to the product
- Time horizon
Demand tends to be more elastic:
The larger the number of close substitutes
If the good is a luxury
The more narrowly defined the market
The longer the time period
Price elasticity of demand formula
% change in QD (divided by) % change in price
Midpoint method
Preferable when calculating the price elasticity of demand because it gives the same answer regardless of the direction of the change.
(Q2 - Q1)/(Q2 + Q1)/2
——————————-
(P2 - P1)/(P2 + P1)/2
Perfectly price inelastic
QD does not respond to price changes
Perfectly price elastic
QD changes infinitely with any change in price.
Unit price elastic
QD changes by the same % as the price
Because the price elasticity of demand measures how much QD responds to the price, it is closely related to the slope of the demand curve
Look at figures in PowerPoint
Total revenue
The amount paid by buyers and received by sellers of a good.
TR = P X Q
Price inelastic demand curve
An increase in price:
Decrease in quantity
Total revenue increases
At points with a low price and a high quantity:
Demand is inelastic
At points with a high price and a low quantity:
Demand is elastic
Price elasticity > 1 =
Elastic
Price elasticity = 1 =
Unit elastic
Price elasticity < 1 =
Inelastic
Income elasticity of demand
Measures how much the quantity demanded of a good responds to a change in consumers income.
Computed as the percentage change in the quantity demanded divided by the percentage change in income.
Higher income raises the QD for normal goods but lowers the QD for inferior goods.
Income elasticity of demand formula:
Q1
DIVIDED BY
Y1
Demand for goods regarded as necessities e.g food, fuels, clothing, utilities, medical services tends to be
Income inelastic
Demand for luxuries e.g sports cars, furs, expensive foods tends to be
Income elastic
Cross - price elasticity of demand
Measure how much the QD of one good responds to a change in price of another good
Computed as the % change in QD of the 1st good, divided by the % change in the price of the 2nd good.
Substitutes have positive cross-price elasticities
Compliments have negative cross-price elasticities
Price elasticity of supply
A measure of how much the quantity supplied of a good responds to a change in price of that good. ( how responsive firms are to changes in price)
The % change in QS, resulting from a 1% change in price
Determinants:
Time period. Supply is more price elastic in the long run. (Firm is allowed to adjust its production levels)
Productive capacity and the ability of sellers to change the amount of the good they produce (if stocks are high - able to respond - elastic)
Size of the firm or industry
Mobility of factors of production
Price elasticity of supply
Computed as the % change in the QS divided by the % change in price:
% change in QS
———————-
% change in price
Calculated in % in order to compare across diff goods & services.
Price elasticity of supply
PES > 1 = supply is price elastic
PES < 1 = supply is price inelastic
PES = 0 = supply is perfectly inelastic
Supply is said to be price inelastic if the quantity responds only slightly to changes in the price.
Midpoint method
(Q2 - Q1) / (Q2 + Q1)/2
——————————-
(P2 - P1)/(P2 + P1)/2
% change in QS over % change in prices
Point elasticity of supply method
P DQs
——x———-
Qs dP
The variety of supply curves
The flatter the slope of the supply curve that passes through a given point, the more elastic the supply
