Topic 3: Elasticity Flashcards
Define the Price elasticity of demand
Price elasticity of demand measures the responsiveness of quantity demand to a change in price
Ed >1
Elastic eg. Tv
Ed < 1
Inelastic eg. Coffess
Ed = 1
Unitary elastic
Price change/Point method
% change in quantity / % change in price
Q2-Q1/Q1
Mid Point Method
change in quantity/ Quantity average x price average / change in price
Availability of substitutes
- The greater number of close substitutes a good has the more price elastic demand
- If price of a good rises, and it has many close substitutes, consumers will be sensitive to change as they can easily switch to another product
- Few substitutes would be inelastic (water, petrol)
Determinates of price elasticity of demand
- Availability of substitute
- Whether it’s essential or luxury
- Proportion of income spent
- Time
- Definition of market - broad or narrow
Luxury or necessity
- necessities ( food) - price inelastic
- Luxury( jewellery, champagne) - elastic
Definition of market
- Demand for goods and services in a broader defined market will be more inelastic than demands for goods in. a narrowly defined market
The proportion of income spent
- Expensive goods are likely to be price elastic as they take up a large proportion of consumer spending
- Cheaper goods are more price inelastic
Time
-If consumers have more time to respond to price change, demand is more price-elastic
- The short run, demand for most commodities is relatively inelastic as they don’t have time to adjust consumption or find substitutes
Relationship between total revenue and price elasticity of demand
TR = PXQ
- When elastic it moves in the opposite direction, as price increases , total revenue decrease and when price decreases, total revenue increases.
- When inelastic it moves in the same direction, as price increases, total revenue increases, this is why inelastic goods are subject to taxes
- When unitary elastic - change in price has an impact on total revenue
Define price elasticity of supply
Price elasticity of supply measures the responsiveness of quantity supplied to a change in price
Measurements
Es = % change in quantity supplied / % change in price
Es = change in quantity/quantity average x price average /change in price
Steeper the curve
More inelastic, quantity change is much smaller for inelastic goods and much larger for elastic goods
Determinates the price elasticity of supply
- Time
- Nature of inventory
- Ability to store inventory
Time
- If producers can respond quickly to price change then supply will be price-elastic
- in short, run may be difficult for produces to suddenly increase output, therefore supply will be more price inelastic
- As time increases supply becomes more elastic
Nature of industry
- The supply of agricultural products tends to be relatively price inelastic while supply of manufacturing goods is more price elastic
- Manufactured goods are relatively easy to produce
Ability to store inventory
- If a producer has the ability to store goods it can respond fairly quickly to a change in demand and so supply in elastic
- Goods that are perishable like fruit can’t be stored therefore supply is inelastic
Agricultural market
- Demand relatively inelastic
- Overtime supply increase due to technology improvement
Housing market
- Supply is inelastic takes time to build houses
- Demand increases due to rising income and population
Tax
Taxes placed on inelastic goods, raise revenue and don’t impact quantity much inelastic
