Topic 3: dynamics of markets: price elasticity Flashcards
What is elasticity?
defined as the percentage change in a dependent variable if the relevant independent variable changes by 1%
formula of elasticity
By dividing the percentage change in the dependent variable by the percentage change in the independent variable
What does Utility mean?
means the amount of satisfaction that someone obtains from consuming an additional unit
Total utility
refers to all the satisfaction per unit gained from the consumption of those goods. It can be found by dividing total utility by the number of goods consumed
Average utility
is the average satisfaction per unit from the consumption of those goods which can be found by dividing total utility by the number of goods consumed
Marginal utility
is the satisfaction gained from the last economic good consumed
What is the law of diminishing marginal utility
when the marginal utility declines as the number of goods consumed increases
How is a marginal utility found
by subtracting successive total utilities
What is called consumer equilibrium
When the marginal utilities of goods purchased by the consumer are equal
How to determine the patterns of consumption
by reference to the prices of goods and their relative marginal utilities
What is consumer equilibrium
is a state of stability in consumer purchasing patterns n which an individual has maximised his or her total utility
The law of demand
states that there is an inverse relationship between a good’s price and the quantity demanded, everything else being the same. If the relative price of a god falls, the individual will buy more of the good. If the relative price rises, the individual will buy less
Wha leads to the law of demand
The assumption of rational behaviour, coupled with the consumer’s willingness and ability o substitute less costly goods when the price go up
What does the price elasticity of demand refer to
the responsiveness of quantity demanded to a change in price. The word responsiveness means that there is a stimulus reaction involved. Some changes or stimuli cause people to react by changing their behavior. Elasticity measures the extent to which people react
When is demand inelastic
When quantity demanded is relatively unresponsive to price changes
When is demand elastic
Where quantity demanded is very responsive to price changes- a small change in price leading to a relatively large quantity demanded
what is the elasticity of demand
is the relationship between proportionate change in price and the proportionate change in quantity demanded
What is the most common elasticity measurement
price elasticity of demand
What does the price of elasticity of demand measure
it measures how much consumers respond in their buying decisions to a change in price
How is price elasticity calculated
by making use of the percentage change in price and quantity, and not absolute changes
Price elasticity of demand formula
percentage change in quantity divided by percentage change in price
Degrees for elastic demanded
demand tends to be elastic for goods and services that are close substitutes, take up a large portion of consumers income, or are perceived as luxuries and whose purchase can be postponed
Degrees of inelastic demanded
When a given change in price causes a smaller percentage change in demand, the good has inelstic demand
like basic needs
When does unit price elasticity occur
when a percentage change in price results in an equal percentage change in demand, in the opposite direction like 10% and 10%
Why doesn’t total revenue not change when the price elasticity of demand is unity?
it is because a given percentage in price will cause an equal percentage change in demand, leaving total revenue unchanged
When does price inelasticity occur
when a change in price causes no change in the quantity demanded. For example, a person with a serious illness might be prepared to buy the same quantity of medicine when its price rises ad may not find it beneficial to increase the quantity they take when its price fails
What is perfect elasticity
When demand is perfectly elastic at a certain price level, demand for the god will be infinite. An increase in price will cause demand to fall to zero. At any price below, the original price the quantity demanded will remain infinite
What happens when demand is elastic
price and total revenue will move in opposite directions so that a rise in price will cause a fall in total revenue and a fall in price will cause a rise in total revenue
What happens when demand is inelastic
price and total revenue will move in the same direction meaning a rise in price will cause a rise in revenue and a fall in price will cause a fall in total revenue
Why doesn’t total revenue not change when the price elasticity of demand is a utility?
a given percentage in price will cause an equal percentage change in demand in the opposite direction, leaving total revenue unchanged
Price elasticity of demand along a demand curve
Price elasticity of demand along most demand curves becomes more inelastic as price falls
The shift in the demand curve
A shift in the demand curve will alter the price elasticity of demand at any given price. An increase in demand will make demand more inelastic. At higher levels of demand, people will be less sensitive to price changes
What is the price elasticity of supply
is a relationship between the proportionate changes in price and the proportionate changes in quantity supplied?
When does elastic supply exist
when a percentage change in price causes a greater percentage change in supply
When does inelastic supply exist
when a given percentage change in price causes a smaller percentage change in supply
The level of spare capacity in the industry
When an industry is operating below full capacity and so there are unemployed resources, supply is elastic
The level of employment
In a situation of full employment, the supply of most goods and services will be inelastic. Supply may be increased by improved productivity
The ability o store the good
Supply will be elastic if the good can be stored. If the price rises, drawing on stocks can increase the quantity offered for sale quickly and if the price falls, adding to stocks can reduce supply
The supply of manufactured goods
to be more elastic as the production process is usually shorter
The supply of mining commodities
will be equally inelastic It takes a long time to increase the capacity of mines to produce bigger quantities
The supply of agricultural goods
will be inelastic because the quantity supplied in any one year is governed by the size of the land planted in the sowing
What determines the elasticity of demand
The availability of substitutes.
The closer to unique a good or service is, the less elastic demand will be because there will be fewer substitutes.
Some gods are habit-forming like alcohol and chocolates.
If it is possible to postpone the purchase of a good
For essential goods such as bread and milk, demand is relatively inelastic, whereas for luxury goods such as vacations and restaurant, the demand is relatively elastic
What does the income elasticity of demand measure
The responsiveness of consumers to changes in income. It is concerned with the relationship between changes in income and changes in demand
Positive income of elasticity
Meaning that in most cases income and demand will move in the same direction an increase in income will lead to an increase in quantity demanded and a decrease in income will cause a decrease in demand
How do goods have income elastic demand
A given increase in income causes a greater change in demand
How do goods have income in elastic demand
Means that a given increase in income causes a smaller change in demand
How do goods have a negative income elastic demand
That a given increase in income causes a greater change in demand
How do goods have a negative income inelastic demand
Means that a given increase in income inelastic demand
Cross elasticity of demand formula
Percentage change in quantity demanded of Good A divided be percentage change in price of Good B
Substitute goods in cross elasticity of demanded
Is positive: an increase in the price of B will lead to an increase in demand for A
Complementary goods of crops elasticity of demand
Will be negative: increase in the price of B will lead to a decrease in demand for A
When two gods are closely related complements. The cross elasticity of demand will have a high negative value
Unrelated goods meaning
they have 0 cross elasticity of demand. Like the rise of water won’t affect a pair of jeans
A change in the price of one good may affect demand for what appears to be unrelated goods because a change in the price of a goodwill affect the peoples purchasing power
