Week 2 - Demand and Supply elasticity

Question 1

What is elasticity?

Answer 1

Elasticity measures the responsiveness of one variable (e.g demand) compared to a change in another (e.g prices)

Question 2

What is price elasticity of demand?

Answer 2

Is a measure of the responsiveness of quantity demanded to a change in price

Question 3

Price elasticity of demand equations (2)

Answer 3

Question 4

ARC price elasticity demand formula

Answer 4

Question 5

Elasticity interpretations (2)

Answer 5

• 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

Question 6

What are the two determinants of price elasticity of demand? (2)

Answer 6

• The number and closeness of substitute goods
• The proportion of income spent

Question 7

The number and closeness of substitute goods (determinants of price elasticity of demand)

Answer 7

The more substitutes there are and the closer they are the greater the price elasticity of demand will be

Question 8

The proportion of income spent (determinants of price elasticity of demand)

Answer 8

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

Question 9

PED and total revenue graph (3)

Answer 9

• 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

Question 10

What is income elasticity of demand (YED)?

Answer 10

Is a measure of the responsiveness of quantity demanded to a change in income

Question 11

Income elasticity of demand formula

Answer 11

Question 12

Income elasticity of demand interpretations (3)

Answer 12

• 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

Question 13

What is cross-price elasticity of demand (XED)?

Answer 13

It measures the responsiveness of quantity demanded of good x to a change in the price of good z

Question 14

Cross-price elasticity of demand (XED) formula

Answer 14

Question 15

Interpretations of cross-price elasticity of demand (XED) (2)

Answer 15

• If +Ve, the goods are substitutes
• If -Ve, the goods are complements

Question 16

What is price elasticity of supply (PES)?

Answer 16

Is a measure of the responsiveness of quantity supplied to a change in the price

Question 17

Price elasticity of supply (PES) formula

Answer 17

Question 18

Interpretations of price elasticity of supply (5)

Answer 18

• 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

Question 19

What is welfare?

Answer 19

Is the health, happiness and fortress of a person or group

Question 20

Impact of price changes of welfare (2)

Answer 20

• When prices fall, consumers benefit relative to producers
• When prices rise, producers benefit relative to consumers

Question 21

Definition of consumer surplus

Answer 21

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)

Question 22

Where is consumer surplus on a graph?

Answer 22

Is on the underside of the demand curve and above the market clearing

Question 23

Definition of producer surplus

Answer 23

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

Question 24

Where is producer surplus on a graph?

Answer 24

Is below the market clearing but above the supply curve

Question 25

Welfare effects after tax on a graph (2)

Answer 25

* 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

Question 26

Impact of Tax incidence when demand is elastic

Answer 26

* 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)

Question 27

Impact of Tax incidence when demand is inelastic

Answer 27

Firms can pass on lots of tax by increasing price as demand has small change when prices change