Elasticity Flashcards
What is the Law of Demand?
inverse relationship between price and quantity demanded
Define price elasticity of demand
measure of price responsiveness
When is a demand elastic?
when an increase in price
-> decreases the quantity demanded a lot
When is a demand inelastic?
when an increase in price
-> decrease the quantity demanded a little
Elasticity rule
elasticity isn’t equal to the slope
BUT
if two linear demand/supply curves run through a point FLATTER IS MORE ELASTIC
Equation for price elasticity of demand
% change in quantity demanded/ %change in price
top= change in quantity demanded/ initial quantity demanded x100
bottom= change in price/ initial price x100
Midpoint method
% Change in X= change in X/ average value of X x 100
average value of X=
(starting value of X + final value of X) /2
Price elasticity
a good can have a price elasticity as low as zero or as high as infinity
Interpreting the price elasticity of demand
<1 = inelastic
>1 = elastic
=1 = unit-elastic
Extremely low elasticity of demand
perfectly inelastic demand has price elasticity of 0
no matter the change in price the demand will be the same
Extremely high price elasticity of demand
perfectly elastic demand has price elasticity of demand = infinity
Unit elasticity of demand
unit elastic demand has price elasticity of demand = 1
Inelastic demand
price elasticity of demand = 0.5
Elastic demand
price elasticity of demand=2
Describe total revenue
TR= Price x quantity
- sellers need to know how elastic demand is so they can plan
- government want to know this information for tax policies
Describe total revenue
TR= Price x quantity
- sellers need to know how elastic demand is so they can plan
- government want to know this information for tax policies
Describe price effect and quantity effect
-when a seller raises the price of a good, there are two countervailing effects
Price effect- after a price increase, each unit sells at a higher price
-> tends to raise revenue
Quantity effect- after a price increase, fewer units are sold
-> tends to lower revenue
What happens when demand is inelastic?
the price effect dominates the quantity effect
- so an INCREASE in price will cause only a slight reduction in the quantity demanded
-total revenue will rise when the price rises
What happens when demand is elastic
the quantity effect dominates the price effect
- so an increase in price will cause significant reduction in the quantity demanded
- total revenue will fall
What happens when demand is unit-elastic
the quantity effect equals the price effect
- so an increase in price exactly balances the reduction in the quantity demanded
-total revenue doesn’t change
1) How do you know if a good is a necessity or a luxury?
for necessities: quantity demanded doesn’t change much in response to a change in price
for luxuries: quantity demanded is more sensitive to a change in price
2) The availability of close substitutes
-fewer substitutes make it harder for consumers to adjust to Q when P changes
-> demand is inelastic
-many substitutes make it easier for consumers to switch brands when prices change
-> demand is elastic
3) the share of income spent on the good
-feels cheaper when we spend a smaller share of income on the good
- feels more expensive when we spend a greater share of income on the good
4) Time elapsed since the price change
-less time to adjust means lower elasticity
-over time consumers can adjust their behavior or find substitutes making demand more elastic
