Mod 2 - Topic 2 - Demand Elasticity Flashcards
What is elasticity?
It is the percentage change in one variable to a percentage change in another.
What is the formula for determining the coefficient of elasticity?
Percentage change in A divided by Percentage change in B
What is the ‘price elasticity of demand’?
It is the percentage change in quantity demanded caused by a 1% change in price.
What is the equation for price elasticity in demand?
Ep = % change Q / % change P
What is arc elasticity?
Elasticity which is measured over a discrete interval of a curve.
What is the formula to determine arc elasticity?
Ep = (Q2 - Q1/(Q1+Q2)/2) / (P2-P1/(P1+P2)/2)
What is point elasticity?
Elasticity measured at a given point of demand (or supply).
What is the formula for point elasticity?
Ep = (change in Q/change in P) x P1/Q1
Change in Q / change in P = the slope
The slope is the -b in the equation Q=a-bP (a = the constant).
So Ep = -b x P1/Q1
How do you determine the quantity?
Q= a - bP
What coefficient means the product has price elasticity?
> 1 or
What coefficient means the product has price inelasticity
-.9 to 0.9
What coefficient means the product has hit unitary elasticity?
Either -1 or 1
What are examples of Elastic products?
Luxury items such as tickets, cheeseburgers, candy, lobster
What are examples of Inelastic products?
Necessities such as petrol, cigarettes, milk, bread
What is the aim of pricing?
To set price where Price of Elasticity of Demand is equal to unit elasticity as this is where revenue is maximised.
How is elastic demand represented on a graph
Downward sloping but only very slightly
How is inelastic demand represented on a graph?
Sharply downward sloping
How is perfect elasticity represented on a graph?
Completely horizontal - this suggests lots of competition and that a change in price will result in a large loss in business (all other factors being equal)
How is perfect inelasticity represented on a graph?
Completely vertical - this suggests that a change in price will not affect sales at all (all other factors being equal)
How is elastic supply represented on a graph?
Upward sloping but only slightly
How is inelastic supply represented on a graph?
Sharply upward sloping.
What are the determinants of elasticity? (4)
- Ease of substitution
- Proportion of total expenditures
- Durability of product (possibility of postponing purchase, repairing or used market)
- Length of time period.
What is the ‘ease of substitution’ referring to?
If there are many substitutes or the product is a good substitute then demand elasticity will be high
What is the ‘proportion of total expenditure’ referring to?
If the proportion of income spent is very small then increases in price are unlikely to affect the buying decision. Eg salt increased from 44c to 54 c it is not a large portion, but petrol, cars, clothes etc may be viewed as more elastic.
What is ‘derived demand’?
The Demand for products or factors that are not directly consumed but go into the production of another (final) product. The demand for such products exist because there is demand for the final product.
What will cause the ‘derived demand’ curve to be more inelastic? (4)
- the more essential the component
- the more inelastic is the demand curve for the final product
- the smaller the fraction of total cost going into this component
- the more inelastic is the supply curve of cooperating factors.
Which is more elastic, a long run demand curve or a short run demand curve and why?
A long run demand curve - as the time period lengthens consumers find ways to adjust to the price change via a substitution or shifting consumption. This plays out as a number of inelastic demand curves which force changes, which in the long run result in a decrease in supply and an elastic demand curve.
Explain the importance between the relationship between price and elasticity?
Alone a price decrease will increase demand, but the elasticity will determine if the increase in demand is enough to increase revenue.
Considering demand elasticity, how will revenue be impacted if prices increase:
a) if elastic
b) if inelastic?
a) revenue will decrease if elastic
b) revenue will increase if inelastic
Considering demand elasticity, how will revenue be impacted if prices decrease:
a) if elastic
b) if inelastic?
a) revenue will increase if elastic
b) revenue will decrease if inelastic
What is marginal revenue?
Marginal revenue is the change in total revenue resulting from changing quantity by one unit.
What is the formula for Marginal Revenue (MR)?
MR = Change in TR / Change in Q
What does in mean for revenue and elasticity if:
a) MR is positive?
b) MR is zero?
c) MR is negative?
a) MR is positive as TR rises (demand is elastic)
b) MR is zero as TR peaks (demand is unit elastic)
c) MR is negative as TR falls (demand is inelastic
How is Marginal Revenue drawn on a graph
It is twice as steep as the demand curve. Price elasticity of demand (Ep) is at the point where marginal revenue crosses the x-axis and shows Ep as the point where total revenue is maximised (unit elasticity).
What is the cross price elasticity of demand?
It is the percentage change in quantity consumed of one product as a result of a 1% change in the price of another product. Often deals with similar goods.
What is the formula for cross price elasticity of demand?
Ex = % change QA / % change PB
What goods does cross price elasticity of demand often use? (2)
- Substitute goods
* Complementary goods
What is a substitute good?
A product that is similar to another and can be consumed in place of it. Two goods are substitutes if the quantity consumed of one increases then the price of the other increases.
What is a complementary good?
A product consumed in conjunction with another. Two goods are complementary if the quantity demanded of one increases when the price of the other decreases.
What is the formula for Arc Cross Elasticity?
Ex = (Q2A-Q1A / (Q1A+Q2A)/2) / (P2B-P1B / (P1B + P2B)/2)
What is the formula for Point Cross Elasticity?
Ex = (Change QA / QA) / (Change PB / PB)
If the sign for the coefficient for cross elasticity is a positive what does it mean?
That the product is a substitute, it is a complement if the sign is negative.
What represents a good substitute?
Greater than 0.5 is a good substitute and less than -0.5 is a good complement
What is income elasticity of demand?
The % change in Q demanded caused by a 1% change in income.
What is the formula for income elasticity of demand?
Ey = % change Q / $ change Y
For most products income elasticity is positive, more earned = more spent. What are the different categories of income elasticity?
Positive - normal
Greater than 1 = superior
Zero - demand is independent of income
Negative - inferior good
What is an inferior good?
A product whose consumption decreases as income increases.
What is the formula for Arc Income Elasticity?
Ey = (Q2-Q1 / (Q1+Q2)/2) / (Y2-Y1 / (Y1+Y2)/2)
What are other demand elasticities?
- Advertising elasticity
- Interest rate elasticity
- Population size elasticity
What is the price elasticity of supply?
Percent change in Q supplied as a result of a 1% change in P
What is the formula for price elasticity of supply?
Es = %Change QS / % change P
What is a price ceiling?
Occurs where governments inflict a maximum price which is below equilibrium and a shortage will occur
What is a price floor?
Where products cannot be sold below a certain price higher than equilibrium and a surplus will occur.
What are excise tax and sales tax?
Excise - specific amount per unit of product
Sales - % of the price of the product or service.
