Unit 6: Elasticity Flashcards
What is Elasticity?
Elasticity is the measure of the responsiveness of a dependent variable to changes in an independent variable.
Elasticity is defined as the percentage change in a dependent variable (the one that is affected) if the relevant independent variable (the one that causes the change) changes by one percent.
What is price electricity
The price elasticity of demand is a measure of the sensitivity of quantity demanded to changes in the price
It measures the relationship as the ratio of percentage changes between quantity demanded of a good and changes in its price
What is the formula for price elasticity of demand (ep)
%change in quantity demanded
———————————————-
% change in price
Give 2 characteristics of elasticity
- Elasticity is independent of the units used to measure price and quantity
- Elasticity of demand is the ratio of two percentages and so elasticity is a number with no units
What are the 5 categories of price elasticity?
- Perfectly in elastic: EP = 0
- In elastic: EP is between 0 and 1
- Unitary elasticity: EP = 1
4 Elastic: EP is between 1 and ~ - Perfectly elastic: EP = ~ (infinity)
Where on the demand curve is price elasticity infinity and where is is zero?
I’m the case of any demand curve which intersects both axis, the value of the ep will be infinity where the graph intersects the price axis, one is in the middle of the curve (midpoint) and zero where the curve intersects the quantity axis
Draw a price elasticity of demand at different points along a linear demand curve.
Why is price elasticity a useful tool in decision making?
Because it can be used to show how much total expenditure by consumers on a product will change should the price of the product change.
If price elasticity is > 1 then…
Total revenue will increase as the quantity sold increases
(Where a change is price of a product leads to a proportionately larger change in quantity demanded. Price changes by 10% and demand changes by 20%)
If price elasticity = 1
Total revenue will remain unchanged. The total revenue of the firm has reached its maximum.
(Where the change is price leads to an equi-proportional change in the quantity demanded. Price change is 10% and change in demand is 10%)
If price elasticity is > 1
Total revenue wall fall as the quantity sold increases
(Where a change in the price of the product leads to a proportionately smaller change in the quantity demanded. Price change = 10% change in demand = 5% )
Draw a diagram illustrating the relationship between price elasticity of demand and total revenue
Describe what will consumers do in a case of perfectly in elastic demand (ep=0)
Consumers will plan to purchase a fixed amount of the product regardless of the price which is charged
In this case producers can raise their revenue by increasing the price charged for the product. As the quantity demanded does not change, raising price results in an increase in total revenue.
What will producers do in the case of inelastic demand < 1
As a result of the fact that the quantity demanded changes proportionately less than the changes in price, producers have an incentive to raise the prices in order to increase their revenue.
Likewise there was a no reason why producers would decrease the price of their product as the revenue received from the increase in quantity demands will not offset the revenue lost due to a decrease in price
I’m the case of unitary elasticity (ep=1) what will producers do?
Changes in the quantity demanded and price are the same. Producers would not gain anything by increasing or decreasing the price of the product.
What do producers do when they are faced with elastic demand (ep >1)
Decreasing the price of the product will raise the total revenue received by producers.
There is no incentive to raise the price charges for the producer as this would decrease total revenue.
