microeconomics - elasticities

Question 1

define income elasticity of demand (YED)

Answer 1

measures the degree of responsiveness of demand of a good to a change in income levels, ceteris paribus.

Question 2

What goods are positive income inelastic ( 0 < YED < 1 )? What does this suggest?

Answer 2

necessities like rice, meat and vegetables.

an increase in income levels leads to a LTP increase in Qd of these goods, ceteris paribus

Question 3

What goods are positive income elastic ( YED > 1 )? What does this suggest?

Answer 3

luxury goods (e.g. branded bags, luxury cars)

an increase in income levels leads to a MTP increase in Qd of these goods, ceteris paribus

Question 4

What goods are negative income elastic (YED < 0 )? What does this suggest?

Answer 4

inferior goods like canned food or secondhand clothing

an increase in income levels leads to a decrease in Qd of these goods, ceteris paribus

Question 5

define price elasticity of demand (PED)

Answer 5

measures the degree of responsiveness of quantity demanded of a good for a given change in price, ceteris paribus

Question 6

PED < 1

Answer 6

inelastic demand

a change in price leads to a LTP change in Qd of the good, ceteris paribus

determinants: short TIME period, small proportion of INCOME, NATURE of good - necessary, few or no close SUBSTITUTES

Question 7

PED > 1

Answer 7

elastic demand

a change in price leads to a MTP change in Qd of the good, ceteris paribus

determinants: long TIME period, large proportion of INCOME, NATURE of good - luxury, many close SUBSTITUTES

Question 8

define price elasticity of supply (PES)

Answer 8

measures the degree of responsiveness of the quantity supplied of a good for a given change in price, ceteris paribus

Question 9

PES < 1

Answer 9

supply is price inelastic

a change in price leads to a LTP change in Qs of the good, ceteris paribus

determinants: short TIME period, low level of INVENTORIES, NATURE of production - long length of production, ease of factor substitution - occupationally immobile, low SPARE capacity

Question 10

PES > 1

Answer 10

supply is price elastic

a change in price leads to a MTP change in Qs of the good, ceteris paribus

determinants: long TIME period, high level of INVENTORIES, NATURE of production - short length of production, ease in factor substitution - capital and labour or occupationally mobile, high SPARE capacity

Question 11

define cross elasticity of demand (XED)

Answer 11

measures the degree of responsiveness of demand of a good given a change in the price of another good, ceteris paribus

Question 12

XED > 0

Answer 12

positive cross elastic demand - substitutes

an increase in price of a good will lead to an increase in demand for its substitute, ceteris paribus

e.g. coke & pepsi

Question 13

define substitutes

Answer 13

substitutes are alternative goods that can be used for the same purpose

Question 14

XED < 0

Answer 14

negative cross elastic demand - complements

an increase in the price of a good will lead to a fall in demand for its complement, ceteris paribus

e.g. petrol & cars

Question 15

0 < |XED| < 1

Answer 15

if two goods are weak complements/weak substitutes

Question 16

|XED| > 1

Answer 16

if two goods are strong complements/strong substitutes

Question 17

XED = 0

Answer 17

if two goods are completely unrelated

Question 18

name 2 limitations of elasticity concepts.

Answer 18

1. ceteris paribus assumption
   - in the real world, more than one factor affecting demand/supply/ped/pes/xed/yed can change simultaneously
2. lack of accuracy and reliability of data
   - sample size is too small to be representative
   - outdated data
   - inaccurate data (households not reflecting personal preferences accurately due to personal reasons)