Elasticity 2 Flashcards
What is the use of elasticity estimates?
- A way of quantifying the responsiveness of market participants to changes in the market.
- A measure of the extent to which buyers and sellers respond to market conditions
Explain concept of PED.
- PED = (percentage change in quantity demanded of good X) divided by (percentage change in price of good X)
- Assumes ceteris paribus, that only price of X changes and all other market conditions kept constant.
- Positive, because of law of demand.
Give the likely attributes of a good which has price elastic demand.
- Availability of substitutes
- Narrowness of category
- Budget Share
- Time period under consideration
Explain why availability of substitutes affects PED
- It determines whether consumers can find another good to consume, which serves the purpose of the original good, when the price of the original good goes up.
Why do habit forming goods have lower PED than goods which can be easily foregone.
- Habit forming goods have very inelastic demand because there aren’t any good substitutes for their addicts, so their %Qd decrease is proportionately smaller than the %price rise.
- Goods whose consumption can be easily foregone or delayed have elastic PED, such as a new bathroom.
Why does ‘meat’ have a higher PED than ‘food?’
- Meat is more narrowly defined than food
- This means that if the price of meat goes up, they can more easily substitute for something else e.g. fish, vegetables.
- They cannot do the same thing for ‘food’ more generally.
- Hence Meat has more elastic (higher) PED.
Why do printers have a higher PED than paperclips?
- Printers constitute a larger budget share than paperclips, so demand for printers more inelastic than paperclips
- Arises because if budget share higher, then impact on consumer’s budget is greater in absolute terms, even for the same % price increase.
Explain why time period considered affects PED.
- Takes time for consumers to change habits, tastes.
- Time to gain information about substitutes.
- People will not commit to large purchases unless they are convinced that the price change will be lasting.
- Delay-able consumption - more elastic demand, such as a new car or conservatory.
What are the features of an inelastically demanded good.
- Poor availability of substitutes
- Short time period considered
- Very small budget share
- Very generic category of goods
Explain the reasons why elasticities may be unreliable.
- Estimates; may be inaccuracies in data collection
- May not reflect full range of price changes
- Ceteris paribus may not hold over time, may be other factors which affect quantity demand and supply for a product.
- Elasticity may change over time, depends on the time period under consideration.
How is elasticity data compiled?
- Sample surveys of consumers [YED]
- Past records of companies [XED]
Why are PED estimates useful for businesses
- Revenue maximisation; inelastic raise price, elastic lower price.
- Long run planning on how demand will vary with price
- Evaluating government taxation.
Explain concept of YED.
– YED = %change in Qd/% change in real income
— Measures the responsiveness of quantity demanded to a change in real income in percentage terms.
— Assuming ceteris paribus, that only real consumer incomes change, so this quantifies a shift in the demand curve.
What does a negative/positive YED mean?
- Negative; inferior good
- Positive; normal good
Explain concept of a normal good
— Positive income elasticity of demand
- Qd rises as incomes increase
— YED > 0, such as hotel rooms, most types of ‘luxury’ holidays, restaurant meals, organic food.
— Draw the relationship between income and Qd of a normal good; has positive gradient
