Elasticity Flashcards
Price Elasticity of Demand
Ratio of % change in quantity demanded with % change in the price
% quantity change / % price change
Elastic demand
- Price Elasticity of Demand > 1
- Horizontal line
Inelastic Demand
- Price Elasticity of Demand < 1
- Vertical Line
Unit Elastic
Price Elasticity of Demand = 1
Extreme Cases
• Perfectly Inelastic Demand - quantity demanded doesn’t change with price change ~> vertical line
• Perfectly Elastic Demand - any change in price drops quantity to zero ~> horizontal line
• Unit-Elastic Demand - same change in price and quantity
Why elasticity matters?
Predicts how changes in the price will affect total revenue earned by producers
Price Effect
Each unit is sold on higher price, which rises revenue
Stronger in Inelastic demand
PED < 1
Quantity Effect
Fewer units are sold, so higher price won’t help. Revenue drops
Stronger in Elastic demand
PED > 1
Determinants of Demand Elasticity
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Cross price elasticity
>( % change in A demand / % Change in B demand )
> Substitutes - Cross price elasticity of demand is positive
> Complements - Cross price elasticity of demand is negative
Income elasticity of demand
% change in quantity / % change in income
> Normal Good - Income elasticity of demand is positive
> Inferior Good - Income elasticity of demand in negative
Price elasticity of supply
% change in quantity supplied / % change in price
> Perfectly Inelastic Supply - Price elasticity of supply is zero
> Perfectly Elastic Supply - Any change in price leads to large change in quantity supplied
Availability of Inputs
Price elasticity of supply is large when inputs are readily available
Small when inputs are difficult to obtain
Time
Price elasticity of supply grows larger when producers have more time to respond price change
