MICRO - 4. elasticity ✅ Flashcards
what is price elasticity of demand
measure of responsiveness of demand after change in price
formula - percentage change in quantity demanded / percentage change in price
how can you tell level of elasticity from values
if PED = 0 then PERFECTLY INELASTIC
if PED between 0 and 1 (% change in QD smaller than P) demand is INELASTIC
if PED = 1 (% change in QD exactly same as P) is UNIT ELASTIC
if PED is bigger than 1 = ELASTIC
factors affecting PED
- number of close substitutes (more subs = more elastic as switching is easier)
- cost of switching between products (costly = inelastic)
- degree of necessity or whether good is luxury (necessities inelastic)
- proportion of income spent (high% = elastic)
- time allowed following price change (longer = elastic)
- good subject to habitual consumption (less sensitive to price inelastic)
- peak or off peak demand (peak = inelastic, off peak = elastic)
- breadth of definition of good/service (broadly defined then inelastic)
effect of indirect taxes
inward shift of supply if tax increases
supplier passes burden onto consumer by increasing price
if product inelastic then suppliers may choose to absorb tax rise by accepting profit reduction
what are benefits and limitations of PED data X
BENEFITS:
- can predict after supply changes - price volatility, after change of indirect taxes - price and qd effects, price discrimination and charging higher prices for inelastic goods
LIMITATIONS:
- problems with incomplete/inaccurate data
- consumer price sensitivity changes
- time/region variations of elasticity of demand
- not all businesses profit maximisers
- product range variations
- rival producers changing market strategies occasionally
what is involved in price elasticity of supply
PES = relationship between change in quantity supplied and changes in price
if supply is ELASTIC then producers increase output without rise in cost/time delay
if supply is INELASTIC then firms find it hard to change production in given time period
which values determine PES
price elastic when PES is greater than 1
price inelastic when PES is less than 1
perfectly elastic when PES = infinity
perfectly inelastic when PES = 0
factors affecting elasticity of supply
- spare production capacity (no rise in cost = elastic)
- stocks of finished products and components (high quality so ability to respond = better = elastic)
- ease and cost of factor mobility (occupationally mobile = elastic)
- time period and production speed (elasticity higher longer time)
how does elasticity determine how much a shift changes quantity versus price
- if QD increases and S is perfectly inelastic then P rises and Q is unchanged
- if S increases and QD is perfectly inelastic then P falls and Q is unchanged
- if D increases and S is perfectly elastic then P is unchanged and Q rises
- if S increases and D is perfectly elastic then P is unchanged and Q rises
what does income elasticity of demand involve
income elasticity of demand measures the relationship between quantity demanded for X and change in real income
% change in demand / % change in income
what is the YED characteristics of normal goods
positive YED so income rises and more quantity demanded and outward demand curve shift
income elasticity between 0 and 1
luxury goods with YED of more than 1
what is the YED characteristics of inferior goods
negative YED so demand falls when income rises
how does income elasticity vary with different products
varies within a product range
downward trend of YED for basic products
knowledge can help predict effect of economic cycle on sales
for normal luxury goods income elasticity > 1 so income rises and more spent on product
for normal necessities and inferior goods income rises and less spent on product
what is cross price elasticity of demand and what does it involve
measures responsiveness of demand for good X following change in price of good Y
how does cross price elasticity change with substitutes
increase in P for one = increase in D for other
CPED is positive
