elasticity Flashcards
price elasticity of demand formula
%change in quantity demanded/ % change in price
elastic demand
3 features
value of PED>1
% change in price causes a larger % in QD
the higher the PED value is, the more elastic demand is for the good
perfectly elastic demand
3 features
PED is infinite
increase in price means D will fall to 0.
C willing to buy all they can contain at p1 but not at a higher price
characteristics of elastic goods (6)
many substitutes
luxuries
large portion of income
elasticity over 1
time to decide if you want it
Sensitive to change in price- most goods have this in the long run
inelastic demand
3 features
PED is between 0 and 1
% change in price will cause a smaller % change in QD
the smaller the PED value, the more inelastic a good is
perfectly inelastic demand
2 features
PED of 0
Any change in price will have no effect in QD
characteristics of inelastic goods (5)
few substitutes
necessities
small portion of income
elasticity 0-1
required now rather than later
Insensitive to change in price – most goods have this in the short run
unit elasticity
PED is 1
% change in the price will cause the same % change in demand.
income elasticity of demand formula
% change in QD of a good/ % change in real income
price elasticity of supply formula
%change in QS/ % change in price
% change in QS
change in supply/ original supply
% change in price
change in price/ orig price
general characteristics of elastic supply (5)
Easy to produce
Low barriers to entry (many firms)
Low cost or generic input
Easy to switch from producing alternate goods
Elasticity coefficient more than 1
general characteristics of inelastic supply (5)
Hard to produce
High barriers to entry (few firms producing the product)
High cost or specialized inputs
Hard to switch as not a lot of goods
Elasticity coefficient less than 1
Determinants of PES- market period
immediate after a change in price. Supply is highly inelastic because firms cant immediately produce more of a good due to the lack of fops
Determinants of PES-Short run
1 feature
firms capacity is fixed and so is at least 1 factor of production. supply slightly more elastic
Determinants of PES-long run
1 feature
firms have time to vary the amount of capital they use so supply is highly elastic. In the long run an increase in price will result in a much greater increase in QS than in the market period or the short run
determinants of PES- the mobility of resources
if resources (labour and capital) can be quicky put into or taken out of production, supply tends to be more elastic. Generally this applies to low skilled manufactured goods the supply of which is more elastic than high-tech, capital-intensive manufactured goods
determinants of PES- The ability to store stocks
If storage costs are low, suppliers can store excess inventory during periods of low demand and release it onto the market when demand increases (non-perishable goods). Goods that are perishable or have a limited shelf life may have a lower elasticity of supply because they cannot be stored for long periods without deteriorating in quality or value.
what does YED measure
how much the demand of a good changes with a change in real income
what is an inferior good
goods that have a negative YED. As income rises, demand falls. A rise in income will mean that inferior good will be replaced by a substitute considered better quality
what is a normal good
positive YED- as income rises so does demand. the size of the demand increase is dependent on the products elasticity. (0<YED>1) everyday consumer products such as clothing, electronics, restaurant meals, entertainment, and vacations. As consumers' incomes increase, they tend to spend more on these goods and services, leading to higher demand.</YED>
what is a superior good
product that people demand more of as they their incomes grow- luxury products e.g top of the range sports car. If the YED of a product is elastic (YED>1) then its a luxury (superior) good they tend to allocate a larger proportion of their budget to purchasing superior goods.
example of an elastic good
luxury item e.g holiday
example of inelastic good
demand don’t change much with the price e.g petrol
example of perfectly inelastic good
quantity demanded or supplied of a good remains constant regardless of changes in its price.
e.g life changing medicine
example of unit elastic good (not specific)
an essential good with lots of substitutes e.g a banana as if the price dropped by 10% then the demand for banana will increase by 10%
example of perfectly elastic good
luxury products, such as jewels, gold, and high-end cars, since their demand is very sensitive to price changes
consumer surplus meaning
Area below the demand curve and above the equilibrium price line
The difference between the price that a consumer is willing to pay for a good or service and the price they actually pay (the equilibrium price)
producer surplus
Area above the supply curve and below the equilibrium price line
The difference between the price that a producer is willing to supply a good or service at and the price that they actually worth on the market (the equilibrium price)
types of market equilibrium
stable
unstable
neutral
what is market equilibrium
Price and output are stable
Supply is equal to demand
what is market disequilibrium
Supply and demand are not equal- excess supply and demand in the market
Cross- Price Elasticity of Demand XED
Measure of how the quantity demanded of one good responds to the change in price of another good
Formula for Cross- Price Elasticity of Demand XED
Percentage change in quantity demanded of good A/ percentage change in price of good B
Does demand contract or extend when prices rise
Contract
Does demand contract or extend when prices fall
Extends
elasticity definition
a measure of the responsiveness of the quantity demanded of a product or service to changes in its price
relationship between inelastic ped and a firms total revenue
when firms increase the price of an inelastic good, the demand will decrease but that much so they are receiving more revenue as people are still buying it e.g petrol
usefulness of p (price) ed (demand) (3)
Firms utilise price elasticity of demand to determine the optimal pricing strategy for their products allowing them to have the greatest revenue possible
helps economists and businesses understand how consumers react to price changes.
helps in forecasting changes in demand due to price changes. It provides insights into how changes in price might affect sales volume, allowing firms to make more accurate predictions about future revenue and adjust production accordingly
usefulness of y (income) ed (2)
economists can make predictions about future consumption patterns, economic trends, and the overall direction of the economy.
helps economists and businesses understand how consumers adjust their spending patterns as their incomes change- understanding these relationships is crucial for forecasting consumer behaviour and making informed business decisions.
usefulness of x (cross) ed (2)
helps determine whether two goods are substitutes or complements. If the cross elasticity is positive, it indicates that the goods are substitutes, meaning an increase in the price of one good leads to an increase in the demand for the other. Conversely, if the cross elasticity is negative, it suggests the goods are complements, meaning an increase in the price of one good reduces the demand for the other.
Understanding the elasticity between their product and competitors’ products helps in setting competitive prices. For example, if a firm discovers that its product has a high cross elasticity with a competitor’s product, it might need to adjust its pricing strategy to remain competitive (e.g decreasing it so consumers buy from them)
usefulness of p (price) es (supply) (2)
PES is crucial for infrastructure planning, particularly in industries where significant lead times are required to increase production capacity. Understanding the elasticity of supply helps in making informed decisions about investing in infrastructure and capacity expansion.
If the supply of a good is highly elastic (PES > 1), firms can easily adjust their production in response to changes in price, maximizing profitability. Conversely, if supply is inelastic (PES < 1), firms may struggle to adjust production quickly, leading to potential shortages or surpluses.
what is ceteris paribus mean
'’all other things being equal’’
as long as all the other factors remain constant the
pes formula
%change in qs/%change in price
are substitutes or compliments positive
positive
how do we know this
If the price of B goes up, demand for A goes up
Coke & Pepsi
are substitutes or compliments negative
compliments
why
If the price of B goes up, demand for A goes down
Printers & Ink
what would the value of a strong subsitute be
around 1.5 for example- higher, more stronger
elastic
people will switch more quicker
what would the value of a weak compliment be
around 0.2
suggests people are not strongly tied to consuming them together
disadavantage of ped- time
time sensitivity- PED can vary over time. In the short run, demand might be inelastic, but in the long run it could become more elastic as consumers find alternatives.
E.g. Petrol demand is inelastic in the short term, but in the long run people might switch to electric vehicles.
A price rise may not affect demand immediately, but it could lead to a larger fall in quantity demanded over time.
Firms must be cautious: what looks profitable now could hurt market share later.
disadvantage of ped- exploitation
can exploit consumers with high prices if inelastic as theyre gaining extra rev that consumers will have to pay
e.g CEO of british gas increased its prices and then gave himself a pay rise of £8.2 million.
unethical, consumer welfare loss esp those on lower incomes as can lead to lower discretionary income
may force government intervention posing an opportunity cost
disadvantage of yed
Consumers don’t always instantly change their consumption habits when income changes.
Time lags can make YED less reliable for short-term business planning.
depending on economy they may not increase consumption or switch from inferior goods as may have incentive to save due to higher interest rate etc
how is yed changing over time a disadvantage
A product’s YED isn’t fixed. As it becomes more common or cheaper, it can shift from being a luxury to a necessity.
E.g. Mobile phones used to be luxury goods (high YED), but now they’re seen as essential (lower YED).
This means past data may not reflect future behavior.
lacks temporal validity
whats a disadvantage of xed in terms of consumer preference
Strong brand loyalty can reduce how responsive consumers are to the price changes of substitute goods.
This means XED might understate the true substitutability between two goods if consumers are emotionally attached to one brand.
E.g. Even if Pepsi gets cheaper, loyal Coca-Cola drinkers might not switch — lowering the XED even though the products are technically substitutes.
whats another to do with the relatiosnhip of the goods
The XED value for Good A with respect to Good B might not be the same as for Good B with respect to Good A.
This makes interpretation more complex.
E.g. The demand for printers might be very sensitive to the price of ink, but ink demand might not change much if printers get cheaper.
if consumers already own one complimetary good, it may mean the demand for other may only increase over time as one may be a long term purchase
could misjudge the strength of relationship as they also may be weak compliments or substitutes
whats a disadvantage of pes about other factors
PES doesn’t consider other factors like availability of raw materials, labor shortages, or production capacity limits which can massively affect supply
governments may put caps on firms for producing pver a certain amount which this doesnt consider
whats another
Supply tends to be more elastic in the long run because firms can adjust their production processes. In the short run, it’s often inelastic – but PES doesn’t always make that clear.
immediate after a change in price. Supply is highly inelastic because firms cant immediately produce more of a good due to the lack of fops
firms have time to vary the amount of capital they use so supply is highly elastic. In the long run an increase in price will result in a much greater increase in QS than in the market period or the short run
