TOPIC 3: ELASTICITIES OF DEMAND & SUPPLY Flashcards
[Definition] Price Elasticity of Demand (PED)
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.
[Definition] Income Elasticity of Demand (YED)
It refers to the degree of responsiveness of DEMAND for a good to a given change in the CONSUMER’S INCOME, ceteris paribus.
[Definition] Cross Elasticity of Demand (XED)
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.
[Definition] Price Elasticity of Supply (PES)
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.
When to use PED/YED/XED/PES?
ΔSS: Use PED
ΔDD: Use PES
ΔY: Use YED
ΔPrice of related good: Use XED
[Formula] PED
PED = %ΔQd / %ΔPrice
Coefficient of PED
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
Coefficient of PED (Special scenarios)
|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
Determinants of PED
TINS
T: Time period
I: Proportion of income
N: Degree of necessity
S: Availability of close substitutes
Broadness of definition
Impact of PED on Total Revenue / Total Expenditure
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
[Formula] YED
YED = %ΔQd / %ΔY
Coefficient of YED
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
Determinants of YED
- Degree of necessity
- Consumer’s income level / Country’s stage of development (determines point 1)
Impact of YED on Total Revenue / Total Expenditure
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
[Formula] XED
XED = %ΔQd for good A / %ΔPrice of good B
Coefficient of XED
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
Impact of XED on Total Revenue / Total Expenditure
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
[Formula] PES
PES = %ΔQs / %ΔPrice
Coefficient of PES
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
Determinants of PES
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
Impact of PES on Total Revenue / Total Expenditure
NIL
Limitations of Elasticity Concepts
- Ceteris paribus assumption is not realistic
- Constant cost assumption is not realistic
- Imperfect knowledge exists
- Time lag exists
