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
