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Econ Higher > Elasticity of Demand and Supply > Flashcards

Elasticity of Demand and Supply Flashcards

1
Q

What is the relationship between P and Qd?

A

Negative. When P goes up Qd goes down. Law of demand.

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2
Q

How much does Qd go down when P goes up?

A

That depends.

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3
Q

For cigarettes if the price goes up what happens to the Qd?

A

It stays relatively the same. This is a necessity

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4
Q

What is price elasticity of demand?

A

A unit free measure that measures the responsiveness of Qd to a change in P.

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5
Q

How do you calculate PED?

A

%ΔQd/%ΔP

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6
Q

Is PED positive or negative and when?

A

It is always negative because when P is negative (i.e. when price goes down) Qd goes up so it is positive. When P is positive (i.e. price goes up) Qd is negative.

We thus ignore the negative sign as it will always be negative.

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7
Q

How do you calculate the %Δx?

A

(X2 - X1)/X2 x 100

ΔX/X2 x 100

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8
Q

So how do we really measure PED? Explain each step

A

(P2 - P1)/P2 x 100

Which you can simplify as

Qd2 - Qd1 P1
————— x ———
Qd1 P2 - P1

which is the same as

ΔQd P1
——- x ——
Qd1 ΔP

which is the same as

ΔQd P1
——- x ——
ΔP Qd1

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9
Q

So what is the final formula for PED?

A

ΔQd P1
——- x ——
ΔP Qd1

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10
Q

How many possibilities are there for the result of PED?

A

3

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11
Q

What are the possible results of PED?

A
  1. %ΔQd > %ΔP
  2. %ΔQd = %ΔP
  3. %ΔQd < %ΔP
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12
Q

When %ΔQd > %ΔP…

What is the PED?

A

D is elastic, i.e. Qd is very responsive to a change in P

PED > 1

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13
Q

When %ΔQd = %ΔP…

What is the PED?

A

D is unit elastic

PED = 1

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14
Q

When %ΔQd < %ΔP

What is the PED?

A

D is inelastic, i.e. Qd is not very responsive to a change in P
PED < 1

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15
Q

How do you calculate TR?

A

P x Q

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16
Q

When D is elastic what is your best move?

A

Decrease the price and total revenue will increase.

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17
Q

Why when D is elastic should you decrease the price?

A

Decreasing the price will increase the quantity demanded by more than the decrease in price and so the total revenue, being P x Q, will increase.

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18
Q

When D is inelastic what is your best move?

A

Increase the price and total revenue will increase

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19
Q

Why when D is inelastic should you increase the price?

A

Because the increase in price will not lead to a bigger decrease in price and total revenue will increase.

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20
Q

When D is unit elastic what is your best move?

A

Nothing, you have reached maximum TR.

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21
Q

When P is elastic what is the relationship between P and TR?

A

Negative. When you increase P lots of people leave the market so Q decreases and thus TR decreases.

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22
Q

When P is inelastic what is the relationship between P and TR?

A

Positive. When you increase P people will stay in the market because the good is a necessity and TR will increase.

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23
Q

Factors that will effect PED:

A
  1. Availability and closeness of substitutes
  2. Percentage of income spent on the good
  3. Luxury vs. necessity
  4. Addiction
  5. Advertisement
  6. The time period that has elapsed since the price change
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24
Q

How does the availability of substitutes effect PED and elasticity?

A

The more substitutes for a good the higher the PED and elasticity because if the price changes it is easier to find a replacement so you leave the market and Qd decreases.
The closer the substitutes for the good are to the good, the higher the PED and elasticity.

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25
Q

How does the percentage of income spent on the good effect PED and elasticity?

A

The more income spent on a good the greater a price change will seem (income effect) and so the more elastic the good becomes.
E.g. if I spent 99% of my income a $1 increase could cause me to leave the market but if I spent 1% of my income I would be more willing to pay the extra dollar.

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26
Q

How does luxury vs. necessity effect PED and elasticity?

A

If a good is a luxury (an extra item that I don’t really need, just for pleasure) such as a bath bomb then a price change would be more likely to cause me to leave the market rather than a necessity such as medicine. I am more willing to succumb to a price change for a necessity therefore it is inelastic.,

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27
Q

How does addiction effect PED and elasticity?

A

If I am addicted to something that good will be inelastic because I need it and thus am more willing to pay higher prices for it.

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28
Q

How does advertisement effect PED and elasticity?

A

Advertising will reduce the competition from substitute goods thus making the good more inelastic.

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29
Q

How does the time period that has elapsed since the price change effect PED and elasticity?

A

Because consumers have a longer period of time in which to change their D for the product.

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30
Q

How can you figure out the slope of a PED graph?

A

rise over run

ΔP/ΔQd

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31
Q

What are the special cases of price elasticity of demand?

A

Perfectly inelastic

Perfectly elastic

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32
Q

What is perfectly inelastic demand?

A

Qd remains the same no matter what the price

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33
Q

What does perfectly inelastic demand look like on a graph?

A

Verticle demand curve

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34
Q

What is an example of a perfectly inelastic good?

A

Drugs and medicine. It is a life and death necessity so you’re willing to pay anything.

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35
Q

What is perfectly elastic demand?

A

You are able to buy/sell as many units as you want at this price but nothing at any other price.

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36
Q

What does perfectly elastic demand look like on a graph?

A

A horizontal demand curve

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37
Q

How can a good be perfectly elastic?

A

You can’t push the price up at all because there are so many perfect substitutes that your consumers will go to their sellers. You can’t push the price down at all because you are making normal profit. P=MC.

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38
Q

Example of a perfectly elastic good?

A

Agricultural products

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39
Q

What part of the demand curve is elastic and what part is inelastic?

A

The top half of the curve is elastic because the price is higher so you cannot afford to buy the good if the price rises. (percentage of income)
The middle is unit elastic and the bottom half is inelastic.

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40
Q

How do you calculate marginal revenue?

A

ΔTR/ΔQ

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41
Q

What is Xedxy?

A

Cross elasticity of demand between two goods (x and y)

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42
Q

What is Cross elasticity of demand?

A

A unit free measure that measures the responsiveness of Qd of good x to a change in the price of good y.

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43
Q

How do you calculate Xedxy?

A

%ΔP y

44
Q

What does it mean if Xedxy = 0?

A

Good x and good y are independent of each other.

45
Q

What does it mean if Xedxy > 0?

A

Good x and good y are substitutes.

i.e. If P and Qd are positive they are substitutes.

46
Q

What does it mean if Xedxy < 0?

A

Good x and good y are compliments.

i.e. price goes down and Qd goes up.

47
Q

How do you calculate Xedxy (complicated)?

A

ΔQdx Py1
——– x ——-
ΔPy Qdx1

48
Q

If the Xedxy was 10 and the Xedxz was 20 what can you tell about these goods?

A

They are both substitutes
x and z are closer substitutes

If you have tea and coffee and tea and coke and the price of tea goes up, the demand for coffee will go up more than the demand for coke as they are closer substitutes. This the Xed will be greater.

49
Q

What does it mean if Xedxy = ∞?

A

x and y are perfect substitutes

50
Q

What is YEd?

A

Income elasticity of demand

51
Q

What is income elasticity of demand?

A

A unit free measure that measures the responsiveness to Qd of a good to a change in income.

52
Q

How do you calculate YEd?

A

%ΔY

53
Q

What does it mean if YEd < 0?

A

Good is inferior

i.e. If Y increases and Qd decreases, good is inferior

54
Q

What does it mean if YEd > 0?

A

Good is normal

i.e. if Y increases and Qd also increases, good is normal

55
Q

What does it mean if YEd is inbetween 0 and 1? (including 0 and 1)

A

D is income inelastic. This product is a necessity.

The demand of water does not increase or decrease depending on income.

56
Q

What does it mean if YEd > 1?

A

D is income elastic
The Qd is very responsive to a change in Y
This product is called a luxury good

57
Q

How do you calculate YEd (complicated)?

A

ΔQd Y1
——- x ——
ΔY Qd1

58
Q

What is PEs?

A

Price elasticity of supply

59
Q

What is price elasticity of supply?

A

A unit free measure that measures the responsiveness of Qs to a change in P.

60
Q

How do you calculate PEs?

A

ΔQs P1
——- x ——
ΔP Qs1

61
Q

What are the factors that might effect PEs?

A

The time you have to change your product
Possibility of substitutes
Capacity
Cost of production

62
Q

How can time taken to change product be split into categories?

A

Immediate run/moment
Short run
Long run
Really long run

63
Q

What is the PEs with an immediate run?

A

Immediate run is on the same day. A supplier has no time to change their entire product so this is perfectly inelastic (no responsiveness).

64
Q

What is the PEs with a short run?

A

PEs is between 0 and 1, very inelastic.

65
Q

What is the PEs with a long run?

A

PEs > 1, it is (very) elastic

66
Q

What is the PEs with a very long run?

A

PEs is perfectly elastic.

67
Q

What does it mean if PEs = 1?

A

Supply is unit elastic.

68
Q

What does it mean if a supply curve goes through the origin?

A

It has a PEs = 1

69
Q

How does the possibility of substitutes effect the PEs?

A

If there is a high availability of substitutes PEs is very elastic as you can switch what you produce easily.

70
Q

How does capacity effect PEs?

A

If a producer is at full capacity then PEs is low and it is inelastic as it cannot produce more if the price is increased. If a producer has unused resources PEs is high and it is elastic as it is able to produce more.

71
Q

How does cost of production effect PEs?

A

If cost of production is high PEs is low and it is inelastic. If cost of production is low PEs is more elastic.

72
Q

Where is elasticity applied?

A

Taxes

73
Q

What are the two types of taxes?

A

Direct and indirect

74
Q

What is direct tax?

A

Unavoidable

e.g. Income tax

75
Q

What is indirect tax?

A

Irrelevant to income, aimed at specific policies

e. g. tax on cigarrettes to stop smoking
e. g. sales tax

76
Q

With sales tax who can the government tax?

A

Producers as it is difficult to tax consumers

77
Q

What are the two ways the sales tax can be inflected on producers?

A

Per unit tax/specific taxes

Percentage/ad valurem

78
Q

What is the difference in graphing per unit tax and percentage tax

A

Per unit tax will shift the supply curve up by the amount of the tax. Percentage tax will curve it proportionally at each P meaning you pay more tax at higher prices.

79
Q

So the producers have to pay all the tax by themselves?

A

No they can pass it on to consumers

80
Q

How do producers know how much tax to pass onto the consumers?

A

They look at PEs and PEd

The highger the elasticity of one side the more likely the burden of taxes will fall on the other side.

81
Q

When looking at taxes what should we calculate?

A 
Incidence of taxes
Consumers price
Producers keep
Government tax revenue
Dead weight loss
82
Q

What is the incidence of taxes?

A

The burden of taxes falls on whom? Consumers or producers

Depends on PEd and PEs.

83
Q

Id PEd>Pes the burden of taxes falls on whom?

A

Producers share of the taxes is higher

84
Q

What are the special cases with taxes?

A 
PEd = 0
PEd = ∞
PEs = 0
PEs = ∞
85
Q

What is it called when PEd = 0 and who assumes the tax?

A

Perfectly inelastic demand, consumers assume full tax

86
Q

What is it called when PEd = ∞ and who assumes the tax?

A

Perfectly elastic demand, producers assume full tax

87
Q

What is it called when PEs = 0 and who assumes the tax?

A

Perfectly inelastic supply, producers assume full tax

88
Q

What is it called when PEs = ∞ and who assumes the tax?

A

Perfectly elastic supply, consumers assume full tax

89
Q

How do we treat taxes on a graph?

A

As if it is an increase in the cost of production
The supply curve shifts up left by t at each price level
Therefore the minimum supply price must also increase by t

90
Q

What does consumers price always equal?

A

PE1

91
Q

How much do producers keep?

A

PE1 - t

92
Q

When PEd = PEs who assumed tax?

A

The tax is split 50/50

93
Q

How do you calculate government tax revenue?

A

t x Q

94
Q

Before tax what is CS, PS and GTS?

A

CS: 1,2,3
PS: 4,5,6
GTS: 1,2,3,4,5,6

95
Q

After what is CS, PS and GTS?

A

CS: 1
PS: 6
Government gain: 2 and 4
GTS: 1,2,4,6

96
Q

After tax what is DWL?

A

Area 3 and 5

97
Q

How do you calculate DWL?

A

GTS before - GTS after

or t*(QE1-QE) / 2?

98
Q

If the government want to collect as much revenue as possible what should they tax?

A

A perfectly inelastic product. Doing that, the tax revenue will be highest and DWL will be lowest.

99
Q

What are subsidies?

A

The opposite of taxes. They are the amount of money that the government gives to producers who either pass it on to the consumer or keep it.

100
Q

How do the producers decide how much subsidy to pass onto the consumer and how much to keep?

A

By looking at PEd and PEs.

When PEd > PEs, producers pay more taxes and producers will receive more subsidy.

101
Q

When looking at subsidies what should we calculate?

A 
Who's going to benefit from the subsidies
Consumers price
Producers keep
Government expenditure
Dead weight loss
102
Q

How are subsidies treated when graphing?

A

As a decrease in the cost of production.

S increases so supply curve shifts down, right.

103
Q

Consumers price with subsidies =

A

PE1

104
Q

Producers price with subsidies =

A

PE1 + sub

105
Q

What is the off cost of subsidies?

A

Taking money away from other projects

106
Q

Where does a DWL from subsidies come from?

A

Over production

107
Q

What does a subsidy do to producers keep and consumers price?

A

producers get more and consumers pay less

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