Elasticity -Chapter 3 (J) Flashcards
What is Elasticity
The responsiveness of one variable to change in another. When price rises and demand falls
4 Types of Elasticity
- price elasticity of demand
- price elasticity of supply
- income elasticity of supply
- cross elasticity of demand
What does elasticity measure
Measures the extent (response) to which quantity will change (demand or supply) due to a change in some relevant factors (price or the price of other good)
Price elasticity of demand is
the responsiveness of a change in demand to a change in price
Factors / determinate affecting elasticity of demand
- time period
- number of close substitutes
- the proportion of income made by the product
- luxury or necessity
Time period
the time it takes for people to change their demand habits (short= elastic, long = inelastic)
Price elasticity of demand or supply greater than 1
elastic
Price elasticity of demand or supply less than 1
inelastic
Price elasticity of demand or supply is 1
unit-elastic
Price elastic goods are…
flexible, a change in price has a big change in demand. eg. housing, restaurant meals, airline travel, foreign travel (likes to pay the lowest price)
Price inelastic goods are…
not flexible, a change in price has little to no change in demand. often necessities or addictive. eg. eggs, beef, stationary, gasoline, alcohol, cigarettes, drugs (will pay any price)
Total revenue formula:
price x quantity demanded ( TR = P x Qd )
If price elasticity of demand is elastic, total revenue…
moves in the opposite direction. (price goes up, TR goes down) (price goes down, TR goes up) inverse relationship
If price elasticity of demand is inelastic, total revenue…
moves in the same direction. (price goes up, TR goes up) (price goes down, TR goes down) positive relationship
Price elasticity of supply is…
the responsiveness of a change in supply to a change in price
Factors / determinates affecting elasticity of supply
- time period (how long it takes to respond)
- nature of industry
- ability to store inventories
nature of industry
durable good - white goods, cars, furniture, clothes, last 1-5 years: elastic, can respond quickly
non durable goods - agriculture products, food, wheat, milk, under a year: inelastic, cant respond because difficult to increase production due to seasonal nature of the industry
Suppliers are less responsive if price elasticity is
inelastic. difficult to react swiftly (quicker) to changes in prices
Suppliers are more responsive if price elasticity is
elastic. can react swiftly (quicker) to changes in price
formula : price elasticity or supply or demand
% change in quanity (d/s)
____________________________________
% change in price
Price discrimination (advanced)
A selling strategy that charges customers different prices for the same product or service based on what the seller thinks they can get the customer to agree to. (firms use their knowledge of elasticity to increase their total revenue)
Price discrimination (basic)
Different consumer groups have different price elasticity. Firms use this knowledge to charge different levels or prices to increase total revenue. (eg charge women more for haircuts cos its inelastic, charge children less for movies cos they don’t have their own income)
Tax incidence
the manner in which the tax burden is divided between buyers and sellers. depends on the relative price elasticity of supply and demand
Burden of the tax falls on consumers when demand is…
inelastic compared to supply
Tax revenue is larger the more…
inelastic demand and supply are
Advantages of taxing inelastic goods
- very effective at helping raise revenue
(could be used to limit the effects of using the good) - has marginal impact on quantity
(effect on industry output and employment will not be as great as compared to a tax on elastic goods)
