Unit 3: Concept of Elasticity Flashcards
Price Elasticity of Demand (PED)
numerical value measuring the degree of consumer’s sensitivity to a change in the product’s own price, caused by variations in supply
Formula: (%Δ in Q)/(%Δ in P)
Arc Formula:ΔQ/(Δ P) x ((P1+PS)/2)/((Q1+Q2)/2)
PED=0 i.e. perfectly inelastic
PED=infinity i.e. perfectly elastic
PED=1 unitary elastic
a percentage change in price results in a smaller/larger/same percentage change in quantity demanded
Sign
shows the type of relationship
Magnitude
shows the strength
Determinants of PED
- Number and closeness of substitutes
- Degree of necessity
- Percentage spent on the commodity relative to expenditure
- Short run vs long run
PED is only positive for Giffen/Veblen goods
Income Elasticity of Demand (YED)
numerical value measuring the degree of consumer’s responsiveness to a change in income, ceteris paribus
Formula: percentage change in quantity/ percentage change in income
Sign: positive - normal good, negative - inferior good
Magnitude: >1 - luxury good, <1 - basic good
Determinants of YED
- Nature of products
- State of the economy
- How quick customers’ desires are satisfied
Cross price elasticity of demand (XED)
numerical value measuring consumers’ sensitivity to a change in the price of another product
Formula: percentage change in quantity of good A/ percentage change in price of good B
Sign: positive - substitutes, negative - complementary
Magnitude: the larger the value the closer the goods are
Price Elasticity of Supply (PES)
numerical value measuring the degree of suppliers’ sensitivity to a change in the product’s own price caused by variations in demand
Formula: percentage change in quantity supplied/percentage change in price
Determinants of PES
- Availability of stocks - more stock = more elastic supply as it is easy to increase production
- Availability of resources - abundant resources = more elastic supply as it is easier to expand production
- Nature of products - durable goods = more elastic supply
- Barriers - low barriers = more elastic supply as more firms can enter the market
- Seller’s objectives - profit maximization = more elastic supply as producers respond quickly to price changes
Elasticity examples
- Elastic demand - smartphones
Demand for smartphones is elastic because there are many substitutes e.g. other brands, older models, etc. if the price increases, consumers can delay their purchase or opt for alternatives, they are not necessities for survival,
- Inelastic demand - medicine
Medicine is inelastic as it is a necessity, consumers are willing to pay almost any price for them since their well-being depends on them, there are often no substitutes
- Normal goods - luxury cars
As consumer income increases, the demand for luxury cars increases as people have more purchasing power
- Inferior goods - instant noodles
As income increases consumers tend to buy fewer instant noodles and prefer higher-quality food. Demand for instant noodles rises in lower-income brackets
- Substitution - Coke and Pepsi
They satisfy a similar need, hence, an increase in the price of Coke can lead to consumers opting for Pepsi, and vice versa
- Complements - printers and ink cartridges
They are used together, meaning demand for one directly influences the demand for the other, a consumer who buys a printer will eventually need ink cartridges to use it
- Elastic supply - clothing
Clothing production can often be ramped up relatively quickly when there is an increase in demand, inputs are readily available, allowing manufacturers to adjust supply more easily
- Inelastic supply - housing
Building new houses takes a significant amount of time due to planning, construction and regulatory processes, land availability is fixed meaning supply cannot expand indefinitely. Even if prices rise sharply, the immediate supply of housing cannot increase substantially
