Elasticity and the responsiveness of demand chap 4 Flashcards
Income elasticity of demand
The percentage change in quantity demanded of a good divided by the percentage change in population income.
Price elastic
Change in price produces a more than proportionate change in quantity demanded.
Price elasticity of demand
The percentage change in quantity demanded divided by the associated percentage change in price.
Price elasticity of supply
The percentage change in quantity supplied of a good divided by the percentage change in the good’s own price.
Price inelastic
Change in price produces less than proportionate change in quantity demanded.
Elasticity
Elasticity provides a way of measuring how sensitive demand (or supply) is to factors such as a change in price. For many goods and services a price increase means that people buy less, but in some cases the price rise has very little impact on quantities consumed. Price elasticity of demand allows us to calculate how much demand changes as a result of a change in price.
The overall demand for health care services is expected to be relatively inelastic, in large part because there are few close substitutes for medical services.
What are the 3 possible ranges of elasticity?
(a), the quantity demanded is constant regardless of the price. If the quantity demanded remains constant when the price changes, then the elasticity of demand is zero and demand is said to be perfectly inelastic. One good that has a low elasticity of demand is insulin. Insulin is of such importance to some diabetics that a price change is unlikely to have much effect on the amount patients will purchase.
(B) elastic demand: If the percentage change in the quantity demanded equals the percentage change in price, the elasticity of demand is 1 and demand is said to be unit elastic.
(C) perfectly elastic: if the quantity demanded is infi nitely responsive to a price change, then price elasticity of demand is infi nity and demand is said to be perfectly elastic.
if the quantity demanded is infi nitely responsive to a price change, then price elasticity of demand is infi nity and demand is said to be perfectly elastic.
(where PED represents price elasticity of demand): If PED > 1 then demand is price elastic (demand is sensitive to price changes)
If PED = 1 then demand is unit elastic
If PED
Calculate price elasticity
First, price elasticity of demand is calculated by dividing the proportionate change in quantity demanded by the proportionate change in price. Note that elasticity is different to the slope of a demand curve. ‘Slope’ measures the absolute change in one variable given an absolute change in another variable.
Slopes’ on the other hand are dependent on the unit in which the good is measured. Consider a demand curve for paracetamol that has quantity measured in terms of number of grams of paracetamol. This will be much steeper than a similar demand curve that has quantity measured in tonnes of paracetamol. However, for each price level the elasticity will be the same for both curves.
What affects the elasticity of demand for a good?
Availability of substitute goods: the more and closer the substitutes available, the higher elasticity is likely to be, as people can easily switch from one good to another if an even minor price change is made. Note that the number of substitutes depends on how broadly a good is defi ned.
Percentage of income: goods that take a large portion of a consumer’s income tend to have greater elasticity.
Time period: elasticity tends to be greater over the long run as consumers have more time to adjust their behaviour and to search for substitutes.
Necessity: the more necessary a good is, the lower the elasticity, as people will attempt to buy it no matter the price, such as in the case of insulin for those that need it.
Who pays: where the purchaser does not directly pay for the good they consume, such as in the case of employer-sponsored health insurance, demand is likely to be more inelastic.
Brand loyalty: an attachment to a certain brand can often make consumers insensitive to price changes, resulting in more inelastic demand.
What happens to the revenue as the price increases?
As the price rises some revenue will be gained on each unit sold but some will be lost because fewer units will be sold. We can now put these two concepts of revenue and elasticity together. If demand is price elastic then revenue will decrease if the price is increased. If demand is price inelastic then revenue will increase if price goes up.
We said before that total revenue is equal to price multiplied by quantity demanded. So if price increases then total revenue can only fall if there is a proportionally larger decrease in the quantity demanded. This is what happens when the price elasticity of demand is elastic. The increase in revenue on each unit sold is more than offset by the decrease in revenue due to a reduction in the quantity sold. The fl ip side to this is that if price elasticity of demand is inelastic then an increase in price will lead to a proportionately smaller decrease in quantity demanded. So the increase in revenue on each unit sold is not fully offset by the decrease in revenue associated with the fall in units sold.
Cross price-elasticity of demand
The percentage change in quantity demanded of a good divided by the percentage change in the price of another related good.
