TOPIC 3: ELASTICITIES OF DEMAND & SUPPLY

Question 1

[Definition] Price Elasticity of Demand (PED)

Answer 1

It refers to the degree of responsiveness of QUANTITY DEMANDED of a good to a given change in the PRICE OF THE GOOD ITSELF, ceteris paribus.

Question 2

[Definition] Income Elasticity of Demand (YED)

Answer 2

It refers to the degree of responsiveness of DEMAND for a good to a given change in the CONSUMER’S INCOME, ceteris paribus.

Question 3

[Definition] Cross Elasticity of Demand (XED)

Answer 3

It refers to the degree of responsiveness of DEMAND for a good to a given change in the PRICE OF A RELATED GOOD, ceteris paribus.

Question 4

[Definition] Price Elasticity of Supply (PES)

Answer 4

It refers to the degree of responsiveness of QUANTITY SUPPLIED of a good to a given change in the PRICE OF THE GOOD ITSELF, ceteris paribus.

Question 5

When to use PED/YED/XED/PES?

Answer 5

ΔSS: Use PED
ΔDD: Use PES
ΔY: Use YED
ΔPrice of related good: Use XED

Question 6

[Formula] PED

Answer 6

PED = %ΔQd / %ΔPrice

Question 7

Coefficient of PED

Answer 7

PED always a negative value
|PED|between 0 and infinity

|PED|>1: Demand is price elastic
- %Δ in price will result in a MTP Δ in Qd, ceteris paribus
0<|PED|<1: Demand is price inelastic
-%Δ in price will result in a LTP Δ in Qd, ceteris paribus
|PED|=1: Demand is unitary elastic
- %Δ in price will result in equal Δ in Qd, ceteris paribus

Question 8

Coefficient of PED (Special scenarios)

Answer 8

|PED|=0: Demand is perfectly price inelastic
- %Δ in price will result in a 0%Δ in Qd, ceteris paribus
|PED|=∞: Demand is perfectly price elastic
- %Δ in price will result in Qd to fall to 0, ceteris paribus

Question 9

Determinants of PED

Answer 9

TINS
T: Time period
I: Proportion of income
N: Degree of necessity
S: Availability of close substitutes

Broadness of definition

Question 10

Impact of PED on Total Revenue / Total Expenditure

Answer 10

Price inelastic (|PED|<1): Price and TR/TE same direction

Price elastic (|PED|>1): Price and TR/TE opposite direction

Unit elastic (|PED|=1): TR/TE remain constant

Question 11

[Formula] YED

Answer 11

YED = %ΔQd / %ΔY

Question 12

Coefficient of YED

Answer 12

YED<1: Inferior Goods
- Demand is inversely related to income

0<YED<1: Necessity (Demand is income inelastic)
- ΔY lead to LTP ΔQd

YED>1: Luxury Goods (Demand is income elastic)
- ΔY lead to MTP ΔQd

Question 13

Determinants of YED

Answer 13

1. Degree of necessity
2. Consumer’s income level / Country’s stage of development (determines point 1)

Question 14

Impact of YED on Total Revenue / Total Expenditure

Answer 14

0<YED<1 (Demand is income inelastic):
Impact on TR/TE is smaller

YED>1 (Demand is income elastic):
Impact on TR/TE is greater

Question 15

[Formula] XED

Answer 15

XED = %ΔQd for good A / %ΔPrice of good B

Question 16

Coefficient of XED

Answer 16

Positive XED: Substitutes
Negative XED: Complements
XED=0: Unrelated goods

XED>1: Close/Strong substitutes
0<XED<1: Weak substitutes

|XED|>1: Close/Strong complements
0<|XED|<1: Weak complements

Question 17

Impact of XED on Total Revenue / Total Expenditure

Answer 17

XED>1 (Good is cross price elastic):
ΔPrice of good B lead to MTP ΔTR/TE of good A

0<XED<1 (Good is cross price inelastic):
ΔPrice of good B lead to LTP ΔTR/TE of good A

Question 18

[Formula] PES

Answer 18

PES = %ΔQs / %ΔPrice

Question 19

Coefficient of PES

Answer 19

PES>1: Supply is price elastic
- %Δ in price will result in a MTP Δ in Qs, ceteris paribus
0<PES<1: Supply is price inelastic
- %Δ in price will result in a LTP Δ in Qd, ceteris paribus

PES=∞: Supply is perfectly price elastic
- Producers are willing to sell at whatever quantity they are able to at the given price
PES=0: Supply is perfectly price inelastic
- Fixed quantity that the producers produce regardless of the price

Question 20

Determinants of PES

Answer 20

MINTS
M: Mobility of FOPs
I: Inventory Level
N: Nature of the Good
T: Time Period
- Very short run: All FOP are fixed in supply
- Short run: At least 1 FOP is fixed in supply
- Long run: All FOP are variable
S: Spare Capacity

Question 21

Impact of PES on Total Revenue / Total Expenditure

Answer 21

NIL

Question 22

Limitations of Elasticity Concepts

Answer 22

1. Ceteris paribus assumption is not realistic
2. Constant cost assumption is not realistic
3. Imperfect knowledge exists
4. Time lag exists