MICRO - LS12 - Elasticity Flashcards
Price elasticity of demand (PED)
It measures the responsiveness of demand given a change in price
Demand is said to be price elastic when…
A change in price causes a proportionally larger change in demand
Demand is said to be price inelastic when..
A change in price causes a proportionally smaller change in demand
Determinants of PED
- number of substitutes
- necessity/luxury
- addictiveness
- time
- proportion of income on the product
- cost of switching suppliers/brand loyalty
Number of substitutes
The more substitutes a product has, the greater the degree of consumer switching will be when there is a price change
So more substitues the more elastic demand will be
Necessity/luxury
- if a product is considered a necessity demand is likely to be inelastic as people need it no matter the price
- luxury products are elastic
Addictiveness
The more addictive the product is the more inelastic it is
Time
Time gives consumers the opportunity to find alternatives
The more time, the more elastic as more substitutes can be foumd
Proportion of income on the product
The greater the proportion of income spent on a product, less amount of customers can afford price rises
So the greater the proportion of income spent on the product, the more elastic demand will be
Derived demand
Comes from the demand of something else
Demand of one product drives the demand for another
E.g. demand in housing results in demand for roofers/builders
Composite demand
Composite demand happens when goods or services have more than one use so that an increase in the demand for one product leads to a fall in supply of the other
E.g. if more milk is used to make cheese, lower supply for yogurt
Joint/complementary demand
demand for one product is directly and positively related to market demand for a related good or service
Effective demand
refers to the willingness and ability of consumers to purchase goods at different prices
PED equation
PED = (%change in quantity demanded)/(%change in price)
Elastic PED value
Greater then 1
Inelastic PED value
Between 0 and 1
Unitary PED meaning
Price and demand go up/down by same amount
Unitary PED value
1
Perfectly inelastic value (PED/PES)
0
Price elasticity of supply definition (PES)
Measures the responsiveness of supply given a change in price
Supply is price elastic when
A change in price causes a proportionally larger change in supply
Supply is price inelastic when
A change in price causes a proportionally smaller change in supply
Determinants of PES
- Time required to produce product
- level of spare capacity
- number of stocks/finished goods available
- time
- perishability of the product
Time required to produce the product
- The greater the time, the more inelastic supply will be
- If it can be produced quickly firms will be able to respond to price changes rapidly
- So products with a short production time tend to be price elastic supply
Level of spare capacity
The greater spare capacity is in an industry the more price elastic supply will be as more factors of production available for production so if price rise the industry/firm would respond quickly to increasing production
Number of stocks/finished goods available
The more finished goods available the more price elastic supply will be, as firms can quickly respond to price change by releasing some/all stocks on market straight away
Time (PES)
Gives firms opportunity to expand/reduce production
- greater time the more price elastic supply will be
Perishability of the product
- the more perishable a product the harder it is to build stocks so more price inelastic e.g. mushrooms
PES equation
PES = (%change in quantity supplied)/(%change in price)
Elastic PES value
Greater then 1
Inelastic PES value
Between 0 & 1
Unitary PES value
=1
Housing market
- at the moment shortage of housing:
- takes time to build - planning permission takes time
- scarce land in UK - small country
- shortage of construction workers (brexit)
- in Uk houses take time to build - use bricks/mortar vs US who use wood/nails
Perfectly elastic PED & PES value
Infinity
Latent demand
Willingness to buy but not yet ability to buy
Individual demand
A consumer’s demand for good/service
Market demand
All consumer’s demands in the market summed together
Uses of PED
- determination of pricing policy/impact on revenue
- indication of competition faced (number/closeness of substitutes)
- price setting in price discrimination
- government decision on which goods to tax indirectly
