Elasticity of Demand Flashcards
Elasticity
• is a measure of how much buyers and sellers
respond to changes in market conditions.
• is the ratio of the percentage change in one variable
to the percentage in another variable.
Elasticity of Demand
is a measure of the degree of responsiveness of the quantity
demanded of a product to given change in one of the independent
variables that affect demand for that product.
Classification of demand elasticity:
- Price elasticity
- Income elasticity
- Cross elasticity of demand
Price Elasticity of Demand
• is the percentage change in quantity demanded given a percent
change in the price.
• It is a measure of how much the quantity demanded of a good
responds to a change in the price of that good.
PED=/midpoint method/
(Q2-Q1)/[(Q1+Q2)]/(P2-P1)/[(P1+P2)]
Sign of PED
The midpoint formula is preferable when calculating the
price elasticity of demand because it gives the same answer
regardless of the direction of the change
PED is always negative, but analyzing and interpreting the
coefficient, ignore the negative sign, and interpret only the
absolute value.
Types of elasticity
- Inelastic demand
- Elastic demand
- Perfectly inelastic demand
- Unit elastic demand
- Perfectly elastic demand
Inelastic
0CQ
Small change in Q
Perfectly Inelastic
E=0
perpendicular to y axis
vertical
Elastic
1>E
CP
Perfectly Elastic
E=infinity
perpendicular to x axis
horizontal
Determinants of PED
Availability of substitute goods • Proportion of the purchaser’s budget consumed by the item • Degree of necessity • Duration of price change • Breadth of definition of a good • Brand loyalty
If the good is a necessity.
Inelastic
If it takes a small portion of the budget.
Elastic
• If the time period is shorter.
Inelastic
The smaller the number of close substitutes.
Inelastic
The good is not a necessity
Elastic
The more broadly defined the market.
Inelastic
If it takes a large portion of the budget.
Inelastic
Long run
Elastic
Short run
Inelastic
Well-known
Inelastic
Not well-known
Elastic- difficult to find close substitutes
The narrowly defined the market.
Elastic-easier to find close substitutes
Total revenue
is the amount paid by buyers and received by
sellers of a good.
Total Revenue equals?
Computed as the price of the good times the quantity sold. Total Revenue (TR) = Price of Good (P) x Quantity sold (Q)
Increase in Price Inelastic
Increase in Total Revenue
Increase in Price Elastic
Decrease in Total Revenue
Decrease in Price Elastic
Increase in Total Revenue
Decrease in Price Inelastic
Decrease in Total Revenue
The income elasticity of
demand
is the percentage change in
quantity demanded divided by the
percentage change in income, as
follows:
Normal Goods
Income Elasticity is positive.
• A higher level of income for a normal good
causes a demand curve to shift to the right for a normal good, which means
that the income elasticity of demand is positive.
• A higher income elasticity means a larger shift.
Inferior Goods:
Income Elasticity is negative.
• Inferior good—a higher level of income would cause
the demand curve for
that good to shift to the left.
• Again, how much it shifts depends on how large the (negative)
income elasticity
Cross Price Elasticity of Demand
Elasticity measure that looks at the impact a change in the price of one good has on the demand of another good.
XED Positive: Substitute Goods
If good A is a substitute for good B, like coffee and tea, then a
higher price for B will mean a greater quantity of A consumed.
XED Negative: Complementary Goods
If good A is a complement for good B, like coffee and sugar, then
a higher price for B will mean a lower quantity of A consumed.
