Unit 3 Elasticity Flashcards
Price Elasticity of Demand (PED) formula
percentage change in quantity demanded/percentage change in price
elasticity
the measurement of how reactive and responsive one variable is when another changes
Price Elasticity of Demand (PED)
a percentage measure of the responsiveness of the quantity of a good demanded to changes in its price
why PED is always negative
law of demand states that quantity demanded changes inversely to price, downward slope
change in quantity demanded formula
Qd(new) - Qd(old)/Qd(old) x 100%
change in price formula
P(new) - P(old)/P(old) x 100%
PED < 1
demand is relatively inelastic
PED < 1
demand is relatively elastic
PED = 1
demand is unit elastic
PED = 0
demand is perfectly inelastic (theoretical extreme)
PED = infinity
demand is perfectly elastic (theoretical extreme)
determinants of PED
number/closeness of substitutes, demand within product groups, proportion of income spent on the good, addiction, degree of necessity, advertising , time period
total revenue
the income received from selling a product
TR formula
P x Q
effect of price increase on total revenue when PED > 1
TR falls
effect of price increase on total revenue when PED = 1
TR stays the same
effect of price increase on total revenue when PED < 1
TR rises
effect of price increase on total revenue when PED < 1
TR rises
effect of price decrease on total revenue when PED > 1
TR rises
effect of price decrease on total revenue when PED = 1
PED stays the same
effect of price decrease on total revenue when PED < 1
TR falls
commodities/primary products
inelastic products that do not have many substitutes
examples of commodities/primary products
agricultural goods, oil, minerals
YED formula
percentage change in quantity demanded/percentage change in income
YED
the responsiveness of the quantity demanded of a good to a change in income
positive YED
normal good
negative YED
inferior good
YED > 1
income elastic
0 < YED < 1
income inelastic
normal good
when income increases, demand for normal goods increases, when income decreases, demand for normal goods decreases
inferior good
when income increases, demand for this good falls, and when income decreases, demand for this good rises
YED = 0
no response to income change
Engel curve (Ernst Engel)
illustrates the relationship between consumer demand and household income
what the engel curve shows
a continuum: at very low incomes, certain goods may be deemed a luxury, as income increases it becomes a necessity, and finally at high levels of income the same good becomes inferior
as income rises (necessities)
people buy more food but the proportion of income spent on food increases more slowly than income
as income rises (luxuries)
quantity demanded rises faster than income, the proportion of income spent on such goods increases faster than income
importance of YED for firms
sales forecasting, pricing policy, diversification
sales forecasting
a firm can forecast the impact of a change in income on sales volume and revenue
pricing policy
knowing YED helps firms decided whether to raise or lower prices following a change in consumer incomes
diversification
firms can diversify and offer a range of goods with different YEDs to encourage positive economic growth and development
importance of YED in explaining changes in the sectoral structure of the economy
as economies grow, their sectoral structure expands from primary to secondary to tertiary production and incomes rise, so there is more demand for manufactured goods and services
Price Elasticity of Supply (PES)
measures the responsiveness of quantity supplied of a product following a change in its price along a given supply curve
PES is always _____
positive
Price Elasticity of Supply (PES) formula
percentage change in quantity supplied/percentage change in price
PES > 1
supply is price elastic
PES < 1
supply is price inelastic
examples of products which have price elastic supply
mass-produced goods, carbonated soft drinks, toothpaste
examples of products which have price inelastic supply
goods which are difficult to supply, fresh fruit and vegetables that take time to grow
PES = 1
unitary price (curve starts at the origin)
PES = 0
supply is perfectly price inelastic; change in price has no impact on the quantity supplied, as there is no spare capacity to raise output
examples of PES = 0
demand-priced concert tickets, football stadium with limited seat capacity
PES = ∞
supply is perfectly price elastic; supply can change without any change in price due to the spare capacity that exists at the current price level, theoretical
examples of PES = ∞
a huge stock of Duracell batteries, any increase in demand will result in more supply without the price being risen
determinants of PES
time, closeness of producer substitutes, unused capacity, storability, stocks, rate at which costs related to producing more increases
graph of PES = 0
vertical
graph of PES = ∞
horizontal
the longer the time period,
the larger the PES
ways firms can improve the value of their PES
create spare capacity, keep large volumes of stocks, improved storage systems to prolong the shelf-life of products, upgrade technology, training employees to improve labor capacity
application of PES
people do not like investing in products that have unstable supply, industries that produce primary commodities are risky because they have larger demand shifts
