Micro - Price, Income & Cross Elasticities Of Demand ✔️ Flashcards
price elasticity of demand & formula
PED = percentage change in quantity demanded/percentage change in price.
income elasticity of demand & formula
PED = percentage change in quantity demanded/percentage change in income
cross elasticity of demand & formula
PED = percentage change in quantity demanded of good A /percentage change in quantity demanded of good B
Price elasticity of demand: unitary elastic, perfectly and relatively elastic, and perfectly and relatively inelastic
Unitary elastic: A good or service is said to have unitary elasticity if a percentage change in price is matched by an equal percentage change in quantity demanded or supplied. For example, if the price of a good increases by 10%, the quantity demanded decreases by 10%.
Perfectly elastic: A good or service is said to have perfect elasticity if a small change in price leads to an infinite change in quantity demanded or supplied. For example, if the price of a good increases by even a small amount, the quantity demanded decreases to zero.
Perfectly inelastic: A good or service is said to have perfect inelasticity if a change in price does not affect the quantity demanded or supplied. For example, if the price of a good increases, the quantity demanded does not change.
Relatively Elastic: When the absolute value of elasticity coefficient is greater than 1, it is referred as relatively elastic.
Relatively Inelastic: When the absolute value of elasticity coefficient is less than 1, it is referred as relatively inelastic.
Income elasticity of demand: inferior, normal and luxury goods; relatively elastic and relatively inelastic
Normal goods: Normal goods are goods for which the quantity demanded increases as income increases and decrease as income decrease, also known as a direct relationship. This means that if consumers have more disposable income, they will be more likely to purchase these goods and if they have less disposable income, they will be less likely to purchase them.
Luxury goods: Luxury goods are goods that are considered to be high-end and expensive, such as designer clothing or luxury cars. Luxury goods tend to be more price-inelastic than normal goods because consumers are willing to pay a high price for them, and the quantity demanded for luxury goods does not change as much as normal goods when the price changes.
Relatively Elastic: A good or service is relatively elastic if a small change in price leads to a large change in quantity demanded or supplied, meaning that it is responsive to the price changes. Relatively elastic goods are typically goods for which there are close substitutes, and consumers are able to switch to these alternatives relatively easily.
Relatively Inelastic: A good or service is relatively inelastic if a large change in price leads to only a small change in quantity demanded or supplied, meaning that it is not responsive to price changes. Relatively inelastic goods are typically goods for which there are no close substitutes, and consumers are not able to switch to alternatives easily.
7 factors influencing elasticities of demand
Availability of substitutes: The more substitutes that are available for a good or service, the more elastic the demand for that good or service will be.
Proportion of income spent: Goods or services that take up a larger proportion of a consumer’s income will tend to have more inelastic demand, because consumers will continue to purchase them even if the price increases.
Necessity of the good or service: Necessities tend to have more inelastic demand, because consumers will continue to purchase them even if the price increases.
Time: The longer the time period considered, the more elastic the demand for a good or service will be, as consumers have more time to adjust to price changes by searching for substitutes or changing their consumption habits.
Brand loyalty: The stronger the brand loyalty, the more inelastic the demand for a good or service will be, because consumers will continue to purchase it even if the price increases.
Product’s characteristics: The nature of the good or service can also affect the elasticity of demand. For example, a product like luxury or designer brands that have unique characteristics and have no close substitutes have more inelastic demand.
Consumer’s level of knowledge: Consumers who have more information and knowledge about the good or service and its substitutes tend to have more elastic demand.
Explain the significance of elasticities of demand to firms and government in terms of: Changes in real income
For firms, if the demand for a good is elastic, then raising prices will significantly decrease the quantity of the good sold, and therefore decrease revenue. If the demand for a good is inelastic, then raising prices will have a smaller effect on the quantity of the good sold and increase revenue.
Explain the significance of elasticities of demand to firms and government in terms of: Changes in the prices of substitute and complementary goods
if the demand for a good is elastic, and the prices of substitute goods decrease, this will lead to decrease in the demand for their good. If the demand for a good is inelastic and the prices of substitute goods increase, this will not lead to a significant change in the demand for their good.
For government, if the demand for a good is elastic, and the prices of substitute goods decrease, this will lead to decrease in the revenue from taxes on that good. If the demand for a good is inelastic, and the prices of substitute goods increase, this will not lead to a significant change in the revenue from taxes on that good.
Explain the significance of elasticities of demand to firms and government in terms of: The imposition of indirect taxes and subsidies
For firms, if the demand for a good is elastic, an increase in the price due to an indirect tax will result in a significant decrease in the quantity demanded, and therefore a decrease in revenue. On the other hand, if the demand for a good is inelastic, an increase in the price due to an indirect tax will result in a smaller decrease in the quantity demanded, and revenue will not be affected as much.
