Week 2 - Demand and Supply elasticity Flashcards
What is elasticity?
Elasticity measures the responsiveness of one variable (e.g demand) compared to a change in another (e.g prices)
What is price elasticity of demand?
Is a measure of the responsiveness of quantity demanded to a change in price
Price elasticity of demand equations (2)
ARC price elasticity demand formula
Elasticity interpretations (2)
- If PED = 0, demand is perfectly inelastic
- If PED = is between 0 and -1 demand is inelastic
- If PED = -1, demand is unit elastic
- If PED is between -1 and -infinity demand is elastic
- If PED = -infinity, demand is then perfectly elastic
What are the two determinants of price elasticity of demand? (2)
- The number and closeness of substitute goods
- The proportion of income spent
The number and closeness of substitute goods (determinants of price elasticity of demand)
The more substitutes there are and the closer they are the greater the price elasticity of demand will be
The proportion of income spent (determinants of price elasticity of demand)
The higher the proportion of our income we spend on a good, the more we will have to reduce our consumption of it following a rise in price therefore demand will be more elastic
PED and total revenue graph (3)
- Where price is elastic price should be decreased to increase revenue
- When price is inelastic the price should be increased
- When price is unit elastic this is the optimal price where maximum revenue is optimised
What is income elasticity of demand (YED)?
Is a measure of the responsiveness of quantity demanded to a change in income
Income elasticity of demand formula
Income elasticity of demand interpretations (3)
- If +Ve, the good is a normal good
- If +Ve > 1, the good is a luxury good
- If -Ve, the good is an inferior good
What is cross-price elasticity of demand (XED)?
It measures the responsiveness of quantity demanded of good x to a change in the price of good z
Cross-price elasticity of demand (XED) formula
Interpretations of cross-price elasticity of demand (XED) (2)
- If +Ve, the goods are substitutes
- If -Ve, the goods are complements
What is price elasticity of supply (PES)?
Is a measure of the responsiveness of quantity supplied to a change in the price
Price elasticity of supply (PES) formula
Interpretations of price elasticity of supply (5)
- If PES = 0, supply is perfectly inelastic
- If PES is between between 0 and 1, supply is inelastic
- If PES = 1, supply is unit elastic
- If PES > 1, then supply is elastic
- If PES = infinity then supply is perfectly elastic
What is welfare?
Is the health, happiness and fortress of a person or group
Impact of price changes of welfare (2)
- When prices fall, consumers benefit relative to producers
- When prices rise, producers benefit relative to consumers
Definition of consumer surplus
Is the difference between the total amount that consumers are willing and able to pay for a good or service (indicated by the demand curve) and the total amount that they actually do pay (I.e market price)
Where is consumer surplus on a graph?
Is on the underside of the demand curve and above the market clearing
Definition of producer surplus
Is an economic measure of the difference between the amount a producer of a good receives (I.e market price) and the minimum amount the producer is willing
Where is producer surplus on a graph?
Is below the market clearing but above the supply curve
Welfare effects after tax on a graph (2)
- The square in black represents government tax revenue
- The triangle is known as DWL (deadweight welfare loss) which is the gap between the original market clearing and the line from bottom of CS and top of PS
Impact of Tax incidence when demand is elastic
- Firms cannot pass on lots of tax by increasing prices when a product is elastic
- The black rectangle represents government tax revenue
- The triangle is the DWL (aka the dead weight welfare loss)
Impact of Tax incidence when demand is inelastic
Firms can pass on lots of tax by increasing price as demand has small change when prices change
