Elasticity Flashcards
(20 cards)
define price elasticity of demand
measures responsiveness of quantity supplied given a change in price
what demands the elasticity of demand
- production lag= long lag= hard to increase production= inelastic
- stocks= big stocks= elastic
- big spare capacity= more elastic= can use spare capacity to increase supply
- time
- substitutability of FOPs= easier to respond to changes= price elastic
- availability of substitutes= more subs= more elastic= more choice for consumers
- cost of switching= e.g. cost of changing mobile contract= less price elastic
- degree of necessity= highly necessary like medicine or insulin= inelastic
- brandy loyalty= inelastic= don’t care about price instead product brand
- time frame= if there more time to search online for cheaper sub= elastic
how to workout PES
%change in QS/ %change in P
define price elasticity of demand
measures responsiveness of quantity demanded given a change in price
define inelastic demand
when prices change, demand and consumers buying habits stay the same
define cross elasticity of demand
measures responsiveness of Q demanded of a good given a change in prices of another
XED formula
% change QD of good A / % change price of good B
use of XED
- if XED is positive, 2 goods are substitute goods
= if price of substitute goes up, QD of the other substitute will go up
= has upwards sloping demand curve - if XED is negative, 2 goods are complement goods
= if price of complement goes up, demand for the other will go down - if XED is more than 1, demand between the goods is price elastic
= when P of one good changes, demand for the other increases proportionately more than demand for other strongly related demand between the goods - if XED is less than 1, demand between goods is inelastic
= price of one good changes, QD for the other changes proportionality less than change in price of good A= weakly related - if XED is 0, demand between goods is perfectly inelastic= no relationship between the goods= e.g. printer and shoes
define and describe effects of income elasticity of demand
measures responsiveness of Q demanded given a change in income
= if YED is high for certain goods, means sales are volatile during the course of the economic cycle vs more stable goods like toothpaste etc due to low YED
YED formula
%change QD/ %change income
what determines PES
- production lag= longer lag= harder to respond to demand changes by increasing production if there’s a long lag= inelastic
- levels of stocks= larger level= more price inelastic
- large spare capacity= more price elastic= if P or AD increases, firm can utilise spare capacity to increase Q
- high substitutability of FOP= easier to respond by increasing production when P or AD goes up= more price elastic
- time period= SR, supply is price inelastic= fixed FOP= hard to increase production due to fixed FOP
describe inferior goods
- a good whose demand drops when people’s incomes rise
- have a negative income elasticity of demand
= if consumer’s real income increases, less of the inferior product is bought
= YED is negative - during economic growth, AD of inferior goods falls= makes them counter cyclical goods= demand rises when economy worsens e.g. during recession due to substitute effect if wages fall quicker than rise in prices
- e.g. own label cereals, lidl or Aldi and public transport
- the income and substitution effects can sometimes work in opposite directions
describe normal goods
- a product or service whose demand increases as consumer income rises, and decreases as consumer income falls
= have positive YED
descrie normal necessities
- positive YED= spend more on product as income rises but not substantially more= low positive YED between 0-1
define commodity good
raw materials used to manufacture consumer products
= price is determined as a function of its market as a whole – by the interaction of market demand and market supply= Oil, Copper and Wheat
describe commodity good price mechanism
- suppliers of commodity markets are the farmers and other producers who grow, harvest or extract the commodity
- demand for commodities comes from the manufacturers, wholesalers and other businesses that want to use the commodity in their production processes
- Commodity markets are seen as very efficient
= markets quickly respond to changes in supply and demand to find an equilibrium price and quantity
= that’s how price is determined= by the interaction of demand and supply
describe demand of commodity goods
- Oil is one of the most heavily traded commodities in the world
= fluctuating prices have important effects for oil producers/exporters and the many countries and businesses that depend on oil as a key raw material
DEMAND DEPENDS ON… - depends on rate of global economic growth= oil is an essential input into many industries= when an economy is expanding, demand for oil rises
= E.G. the growth of Chinese economy= increase in demand for crude oil from China - depends on relative prices of oil substitutes e.g. market price of alternatives like gas or bio-fuels
= if LR reliable and relatively cheaper substitutes for oil can be developed, expect to see a reduction demand away from oil towards the emerging substitutes - if the winter in North America is fierce, then the global oil price rises as the USA and Canadian economies raise their demand for oil to fuel household heating systems and workplaces
price volatility of primary commodities
- demand is price inelastic as goods are necessities and lack good substitutes
- supply is price inelastic due to large production lag e.g. agriculture takes long time to grow and harvest produce and hard to store commodities
= steep demand and supply curves= creates large changes in price
= high price volatility - weather like flood would decrease supply shift
- high global growth= increase demand shift
is price volatility a concern
- if prices increase due to inelastic demand, producers benefit from higher revenues= increase income and SOL
- if prices fall due to more substitutes as a result of tech or less demand in recession= decrease profit and development= risk absolute poverty in LICs as they would drop out of market
= would also reduce incentive of investment due to price volatility= high COP
disadv of supply and demand theory
producers and consumers don’t have perfect info
= don’t always act rationally like model suggests
