Price elasticity of demand and supply Flashcards
Elasticity of demand
A measure of how much quantity demanded of a good or service changes in response to a change in another variable, such as price or income.
PED formula
%change QD / %change Price
PED > 1 name and meaning
Price elastic demand
A change in price leads to a proportionately greater change in the quantity demanded.
0 <PED <1
Price inelastic demand
A change in price leads to a proportionately smaller change in the quantity demanded.
PED = 1
Unitary elastic demand
A change in price leads to a proportionately equal change in the quantity demanded.
PED = 0
Perfectly inelastic demand
A change in price leads to no change in the quantity demanded.
Ped = infinite
Perfectly elasric
Any change in price would lead to an infinite change in the quantity demanded.
Determinants of price elasticity of demand (4)
- Number and closneses of substitutes
- Nececity
3.Time period - proportion of. income spend
PED NPD - Number and clossenes of substitutes
More substitures –> more elastic
More similar subsitutres –> more elastic
PED NPD - degree of nececity
The greater the level of necessity for the consumer, the more inelastic the demand of the good will be.
The more widely a good is defined, the more inelastic is its demand.
PED NPD - time period
The demand for a good will be more inelastic in a short period of time than in a longer period of time.
as consumers do not have time to look ofr alternatives in short run
Deterinants of PED def
determinants of price elasticity of demand (PED) influence how sensitive the quantity demanded of a good is to changes in its price.
When PED is inelastic consumers pay..
When the demand is relatively inelastic, the tax incidence falls more on consumers than producers.
consumers –> more
producers –> less
when PED is elastic consumers pay .. producers pay..
When the demand is relatively elastic, the tax incidence falls more on producers than consumers.
producers –> more
consumers –> less
Goverment earns more revenue when.. PED
for a good is inelastic
When PED for a good is inelatstc and subsidy or tax is imposed…
less change unless major tax
When PED for a good is elastic and subsidy or tax is imposed…
More impact on production and consumption
YED - income elasticity of demand
A measure of how much quantity demanded of a good or service changes in response to an income change.
YED formula
%Change QD / %change Income (Y)
YED is positive (YED > 0)
As incomes increase, quantity demanded of a good increases; and as incomes decrease, quantity demanded decreases.
NORMAL GOOD
YED is negative (YED < 0)
as incomes increase, quantity demanded of a good decreases; and conversely, as incomes decrease, quantity demanded increases.
INFERIOR GOOD
YED < -1
YED > 1
Income elastic demand
A change in income leads to a proportionately greater change in the quantity demanded.
–1 < YED < 1
Income inelastic demand
A change in income leads to a proportionately smaller change in the quantity demanded.
YED = 0
Perfectly income inelastic demand
A change in income leads to no change in the quantity demanded.
(Goods with a positive YED value close to zero are considered necessity goods.)
graph: linea recta
YED = 1
A change in income leads to a proportionately equal change in the quantity demandeD
Importance of YED for firms
In periods of economic recession, goods and services with the highest YED (YED > 1) will be the ones whose demand and quantity demanded will suffer the largest fall.
However, products with low YED (YED < 1) may avoid a large reduction in sales, and inferior goods (YED < 0) are likely to experience an increase.
YED and sectoral change
As the economy grows and achieves higher levels of national income , the demand for manufactured goods will increase more rapidly (with higher YED) than demand for agricultural products (with lower YED), as consumers are likely to have met their basic needs.
When an economy achieves a high level of national income, consumers will spend disproportionately more in the tertiary sector (even higher YED) than in the primary and secondary sectors.
PES
A measure of how much the quantity supplied of a good changes when there is a change in its own price.
PES FORMULA
%chnageQS/ %changeP
PES is alwats
a positive number because the price and the quantity supplied always move in the same direction.
PES > 1
Price elastic supply
A situation where a change in price leads to a proportionately greater change in the quantity supplied.
0 < PES < 1
Price inelastic supply
A situation where a change in price leads to a proportionately smaller change in the quantity supplied.
PES = 1
A situation where a change in price leads to an equal change in the quantity supplied.
PES = 0
Perfectly inelastic
A situation where a change in price leads to no change in the quantity supplied.
PES = ∞
Perfectly eleastic
A situation where a tiny change in price would lead to an infinite change in the quantity supplied.
Determinants of PES (4)
Time period
Mobility of factors of production
Unused capacity
ability to store stock
NPD PES Time period
The longer the time period considered, the more elastic the supply will be.
NPD PES Mobility and cost of factors of production
The greater the mobility (flexibility) and lower cost of factors of production, the more elastic the supply will be.
NPD PES Unused capacity
The greater the spare (unused) capacity, the more elastic the supply will be.
NPD PES ability to store stock
If a firm has the capacity to store stock, which means keeping inventories of a good in a warehouse, the supply can be more responsive to a change in price.
