Micro part 4- Elasticity and PED

Question 1

What is elasticity

Answer 1

1. The responsiveness of a variable’s sensitivity to a change in another variable

Question 2

What is PED

Answer 2

1. The measure of the responsiveness of quantity demand to a change in price
2. = % change in quantity demanded / % change in price

Question 3

What factors effect PED

Answer 3

1. Availability of substitutes
2. Necessity
3. Depend on the time period:
4. Percentage of income spent on good

Question 4

How does availability of substituted effect PED

Answer 4

1. since when increases in price when there are substitutes available it means consumers will switch to the other good.
2. Also depend on width of market definition for example demand for food is inelastic since the substitutes but the submarket e.g. white bread in the bread market is elastic since there are many substitutes for this.
3. Less substitutes PED < 1

Question 5

How does necessity effect PED

Answer 5

1. even if prices increase consumers still demand since its needed for human survival.
2. Same applies for addiction but to a lesser extent. 3. Greater addiction then PED < 1

Question 6

How does time period effect PED

Answer 6

1. in the s.r. may be locked into contracts so PED < 1

2. in the l.r. are released from lock ins so PED > 1

Question 7

How does Percentage of income spent on good effect PED

Answer 7

1. when more expensive then a % change will have a higher absolute change on price than a lower price good.
2. Higher proportion means PED > 1

Question 8

Who does the burden of indirect tax fall one

Answer 8

1. Burden of an indirect tax can either fall on consumer or producer
2. when PED is > 1 then burden on producer
3. PED < 1 then burden on consumer

Question 9

Why can a producer put tax on the consumer when demand is inelastic

Answer 9

1. since they know the increase in price is unlikely to effect demand too significantly so their profits aren’t harmed

Question 10

Why is gov.rev lower when PED is elastic

Answer 10

1. since the tax has a greater change on quantity demanded meaning less is demanded so gov. makes less tax revenue,
2. But good when want to reduce demand for that good

Question 11

What is a subsidy

Answer 11

1. Subsidy – payment from gov. to firms to encourage production of a good and lower AC

Question 12

Who benefits from subsidy and when

Answer 12

1. The benefit can go to consumer or producer
2. when PED is inelastic or PES is elastic then consumer benefits as there is a greater change in price
3. when PED is elastic or PES is inelastic then producer benefits most because there will be very little change in price. This is because firms don’t pass on subsidy, instead absorb and raise profit

Question 13

How do firms use PED

Answer 13

1. increase or decrease price based on its effect on revenue e.g. increase price if PED inelastic.
2. used in price discrimination strategies

Question 14

How is PED used to increase or decrease price

Answer 14

1. TR is maximised when PED = 1 so should set price to the midpoint of the demand curve.
2. If PED is inelastic then a % increase in price will be greater than the % decrease in qd

Question 15

How is PED used in price discrimination

Answer 15

1. 3rd degree where they segment markets and charge higher prices for the same good based on different PED e.g. rush hour has PED inelastic

Question 16

How does the government use PED

Answer 16

1. tax/subsidy policies e.g. how to maximise revenue or reduce demand for elastic PED goods
2. e.r. policy using Marshall Lerner condition

Question 17

What is YED

Answer 17

1. YED – responsiveness of qd to a change in income

Question 18

When is the good inferior, normal and luxury

Answer 18

1. When YED < 0 (negative) then inferior good
2. When 0 < YED < 1 (positive) then is a normal good
3. When YED > 1 (positive) then is a luxury good

Question 19

When might firms switch to producing more luxury goods

Answer 19

1.During periods of growth and rising incomes, firms may switch to producing more luxury goods

Question 20

What are the uses of YED

Answer 20

1. sales forecasting
2. classify goods
3. determine product pricing depending on changes in income in economy

Question 21

How is YED used for sales forecasting

Answer 21

1. depending on the level of income in the economy (rise or fall?) know if they should produce inferior or luxury goods.
2. Want diversity so can make lots of profit in recession with luxury goods but continue to make profit in recession with inferior

Question 22

What is XED

Answer 22

1. XED – the responsiveness of a change in demand of one good X to a change in price of good Y

Question 23

When are goods complementary, unrelated and substitute

Answer 23

1. When XED < 0 the complementary goods
2. When XED = 0 the unrelated
3. When XED > 0 the substitute goods

Question 24

What are the uses of XED

Answer 24

1. firms can identify competitors by looking at the XED (substitutes?).
2. used to identify the number of competitors in a market. (collusion)
3. identify products that could be substitutes to existing goods that they produce. This can reduce conflict between the two goods, and prevent ‘cannibalising’ their existing range of goods

Question 25

Why is identifying competitors important.

Answer 25

1. It allows them to know how to react should the price of a substitute good change e.g. if competitor good has a price fall then they know to reduce demand so they can maximise demand

Question 26

What is PES

Answer 26

1. Price elasticity of supply

2. PES – the responsiveness of quantity of quantity supplied to a change in price

Question 27

What are the determinants of PES

Answer 27

1. time scale as in s.r. firms cannot easily increase supply.
2. spare capacity as if lots then increase supply quickly to respond to demand.
3. FoP mobility

Question 28

How does time scale determine PES

Answer 28

1. This is because capital is often the FoP which is fixed in the s.r. since it can take time to increase machinery so hard to increase production.
2. In the l.r. all FoP are variable so can increase capacity.
3. L.r. means P > 1

Question 29

How does spare capacity determine PES

Answer 29

1. Can increase output without a rise in costs
2. More spare capacity means PES > 1
3. If good is perishable then cannot do this.

Question 30

How does FOP motility determine PES

Answer 30

1. those that can easily change their work force to produce different goods due to transferrable/easily trained skills will have goods with higher PES since can easily produce the good, even if originally produced another good.
2. Means less barriers to entry

Question 31

What are the uses of PES

Answer 31

1. see how changes in the e.r. affects ability to export
2. evaluate competitiveness by seeing how quickly can respond to changes in price.
3. effectiveness of government policies e.g. if PES is inelastic then burden of taxes will fall on firms

Question 32

How can PES allow you to see how changes in e.r. affects ability to export?

Answer 32

1. can domestic industries respond to increases in foreign demand for exports.
2. Especially important for export reliant industries and where e.r. policy is an important part of macro policy

Question 33

How does PES allow you to evaluate competitiveness

Answer 33

1. Want high PES since it allows them to be more competitive as can respond quickly to changes in market conditions, allowing them to generate more revenue and profit

Question 34

How can PES be improved

Answer 34

1. create more spare capacity
2. storage
3. occupationally mobile workers who can do a range