Elasticity

Question 1

Price elasticity of demand

Answer 1

How much quantity demanded changes when prices change

Demand curve is elastic when an increase in price reduces the quantity demanded a lot (and vice versa)

When the same increase in price reduces price just a little (and vice versa), demand curve is inelastic

The more responsive quantity demanded is to change in price, the more elastic the demand curve is

Question 2

Elasticity rule

Answer 2

If two linear demand (or supply) curves run through a common point then the flatter curve is more elastic

Question 3

Measuring elasticity

Answer 3

Price elasticity of demand =

% change in quantity demanded/% change in price

Ex: If price of nuggets increases by 16% and quantity demanded thus decreases by %8 then our equation would be: -8% (price decreased, thus, negative)/ 16%
= -0.5

ONLY FOR PRICE ELASTICITY OF DEMAND: Okay to drop the minus sign because price and quantity demanded will always move in different directions (law of demand)

Question 4

Defining elasticity

Answer 4

A good can have a price elasticity as low as 0 and as high as ∞

If E < 1, demand/supply curve is inelastic
If E > 1, demand/supply curve is elastic
If E = 1, demand/supply curve is unit elastic

Question 5

Extremely low elasticity of demand (Ed = 0)

Answer 5

Change in price leaves demand curve unchanged

Demand curve would look like a vertical line

Question 6

Extremely high elasticity of demand (Ed = ∞)

Answer 6

Change in price results in consumers buying 0 (if higher prices) or infinite (if lower prices) of a good

Demand curve would look like a horizontal line at price point

Question 7

Unit elasticity of demand (Ed = 1)

Answer 7

A change in price will yield an identical change in quantity demanded

If prices rises by 12%, quantity demanded will fall by 12%

Question 8

Factors determining elasticity of demand

Answer 8

1. Availability of close substitutes
   a. Fewer substitutes makes it harder for consumers to adjust to change in price, demand is inelastic
   b. Many substitutes makes it easier for consumer to adjust to change in price, demand is elastic
2. Whether the good is a necessity or a luxury
   a. Demand for necessities like water does not change much when price changes, inelastic
   b. Demand for luxuries changes more when price changes, elastic
3. Share of income spent on the good matters
   a. If good is perceived as cheap, our demand is more inelastic
   b. If good is perceived as expensive, our demand is more elastic
4. Length of time elapsed since price change
   a. Less time to adjust to price change means lower elasticity
   b. More time to adjust gives consumers a chance to find substitutes, higher elasticity

Question 9

Elasticity of supply

Answer 9

Supply curve elastic if a rise in price increases quantity supplied a lot (vice versa)

Inelastic if a rise in price increases quantity supplied just a little (vice versa)

Question 10

Perfectly inelastic supply (Es = 0)

Answer 10

Change in price leaves quantity supplied unchanged

Vertical line

Question 11

Perfectly elastic supply (Es = ∞)

Answer 11

At a certain price, and only at that price producers will make any quantity of a good (anything higher producers will make ∞ units, anything lower producers will make 0)

Horizontal line at price point

Question 12

Factors determining price elasticity of supply

Answer 12

1. Availability of inputs
   a. If increasing production is expensive, supply will be inelastic
   b. If increasing production is cheap, supply will be elastic (easier for producers to produce more)
2. Time
   a. The more time a producer has to respond to a price change, the more elastic supply is
   b. Elasticity of supply in the long run tends to be higher than in the short run