Topic 5: Elasticity and its' applications Flashcards
What is the price elasticity of demand based on?
The law of demand: As prices increase, the quantity demanded decreases
But why do we need to consider the price elasticity of demand?
It tells us HOW MUCH the quanitty demanded changes when prices change
Elastic Demand
When an increase in price reduces quantity demand by a LOT
When a decrease in price increases quantity demand by a LOT
Inelastic Demand
When a increase in price reduce the quantity demanded by a little
When a decrease in price increases the quanitty demanded by a little
What does a Inelastic demand curve look like?
The letter I, it is very steep
What does a Inelastic demand curve look like?
The letter I, it is very steep
What does an elastic demand curve look like?
Very flat, looks more like an E than an I
Define price elasticity of Demand
Measure of the responsiveness of the quantity demanded of a good to a change in the price of that good!!!
First Formula for Price elasticity of demand
NOTE
1) IEdI= %change in quan demanded/ %change in price
This one has to be in percents!!! IF given 10% change in price dont calc anything
If not given %change in price, y2-y1
What does numerical elasticity mean?
Lets say if there is an elasticity of 2, that the change in quantity is twice as large as the change in price!!!!!!!
Lets say if there is an elasticity of 0.5, that the change in quantity is half that of the change in price
Why does elasticity formula 1 not work?
Because calculating a->b and b-> give different results!!!! must use midpoint formula
Which formula do we use to calculate the price elasticity of demand?
USE THIS :
Midpoint formula= (New-Initial)/(Average) x 100
Use it to calculate both %change in price and quantity, then input it into the original formula
%change in quantity/%change in price
2 KEY THINGS IN MIDPOINT FORMULA
1) NEW-INITIAL
2) X 100!!!!!
Perfectly inelastic Demand
Meaning
Example
The demand curve is vertical!, |Ed|=0
Quantity demanded does not change even as prices change from 0-100+
Air Water
Elastic Demand
|Ed|>1
When the % change in quantity demadned is greater than the % change in price
QUANTITY MOVES MORE THAN PRICE
Inelastic demand
|Ed|<1
When the % change in quantity demanded is smaller than the % change in price
Quantity moves less than the price!!!
Unit Elasticity of Demand
|Ed|=1
%change in price=%change in quantity demanded
Perfectly Elastic Demand
|Ed|=Infinity
At any price increase, quantity demand is zero; At any price reduction infinite quanity demanded
What determines the Price Elasticity Of Demand of a good?
FACTORS THAT INFLUENCE
- Availability of Clsoe substitutes
- Necessity or Luxyry
- How defined the market is
- Time horizon
- Size of purchase relative to consumers budget
Availability of close subs influence on elasticity of demand
THE MORE SUBS= MORE ELASTICITY
chocolates
THE LESS SUBS= LESS ELEASTICITY
eggs
Necessity or Luxury influence on price elasticity of demand
Necessity= Less Elasticity bc NEED
Luxury= More elasiticty bc want
How defined the market is influence on price elasticity of demand
HIGHLY DEFINED MARKET=more subs= HIGH ELASTICITY
cauliflower
Barely defined market=less subs= low elasticity
food
Time horizon influence on price elasticity of demand
Directly following price incerase= inelastic demand bc cant switch right away
longer time= more elasticity
EX: fuel prices skyrocket, short run inelastic, long run elastic bc switch to better cars
relative to Size of consumers budget influence on price elasticity of demand
Small size in consumers budget= INELASTIC DEMAND BC it dont make a difference if buy or not
BIG SIZE in consumers budget= ELASTIC DEMAND BC it makes a lot of difference if you buy or not
How are price elasticity of demand and total rev related?
Ed is about how much quantity demanded is affected with price changes
Total Rev= P x Q so
PRICE ELASTICITY OF DEMAND DIRECTLY DETERMINES THE TOTAL REVENUE AFTER A PRICE CHANGE
When prices change what happens
Total Revenue also changes!
What is total revenue diagram?
the square underneath a graph plot point, P X Q
When demand is elastic which way does price and total revenue go?
OPPOSITE DIRECTIONS!
When demand inelastic, which way does price and total revenue go?
Same direction
When demand is unit elasticity which was does price and revenue go
REV ALWAYS STAYS CONSTANT
Is the elasticity on the demand curve cosntant like the slope?
No it is NOT! Slops is the ratio of change bwtween price and quantity; elasticity is the ratio of percentage changes
Explain the elasticity levels on a demand curve?
HOW TO CHECK THIS?
Above the midpoint, demand is elastic,
AT MIDPOINT, DEMAND IS UNIT ELASTIC
Below Midpoint, demand is inelastic
Total rev x Elasticity level rules (opposite or same direction)
What is cross price elasticity of demand
measure of how much the quantity demanded of good A reacts to the price changes of good B!!!!!!
MEASURED B/W SUBS AND COMPS!!
Formula for cross price elasticity of demand?
%change in quantity demanded of good a/ %change in price of good b
same q/p but DIFF GOODS!
RESULTS for cross price elasticity of demand?
Positive: SUBSTITUTES
(if price of good a goes up, demanded quantity of good b goes up!!! logic)
Negative= complements
(If price of good a goes up, demanded quantity of good b goes down)
0= unrelated
Income elasticty of demand
Measure of how much the quqantity demanded of a good responds to changes in income
-normal goods
-inferior goods
RESULTS for income elasticity of demand
-positive but less than 1 NORMAL & NECESSITY
-positve and greater than 1 NORMAL & LUXURY
-negative INFERIOR
Priice Elasticity of Supply
How much does quantity supplied respond to a change in price
Inelastic supply means that
Quantity supplied can only change little with price changes!
Elastic supply means that
Quantity supplied can change a lot wiht price changes
On a slope, where is supply elastic and inelealstic and unit elastic?
IMPORTANTTTTTTTTTTTTTTTTTTTTTTTTTTTTTTTTTTT
On a slope where is demand inelastic elastic and unit elastic
Supply:
Inelastic at the top, Unit Elastic in the centre, Elastic at the bottom
(Elastic at the bottom because there is more capcity for production if needed)
Demand:
Elastic at the Top, Unit Elastic in the centre, Inelastic at the bottom
(Low price, high quantity= inelastic;High price Low Quantity Elastic)
What are two factors that influence Elaticity of Supply
Longer time period= Elastic
More resources to substitue with= Elastic
PS NC on cross price elasticity?
Positve number? SUBSTITUTED
Negative number? COMPLEMENTS
Why is lower half of demand curve inelastic?
bc lower prices= lower part of consumers wallet= inelastic!!!
When you are given numbers for % change questions
Just use them love dont do any extra math
WHAT IS CRITICAL IN ECON VARIABLES?
ONLY ONE CAN CHANGE!!!! YOU CANT HAVE MULTIPLE SHIFTINF VARIABLES!
