week 2 - PED

Question 1

What is PED ?

Answer 1

Price elasticity of demand: the responsiveness of the quantity demanded to a change in price

ped = change in QD/ % change in the price

Question 2

What are the different elasticities ?

Answer 2

Unit elastic: A change in price causes a proportionately equal change in the quantity demanded ϵD = 1

• Elastic: A change in price causes a proportionately larger change in the quantity demanded ϵD > 1
• Inelastic: A change in price causes a proportionately smaller change in the quantity demanded ϵD ∈ (0, 1)

Elasticity - y is bigger than x

Question 3

What determines the price elasticity of demand?

Answer 3

• Substitute goods: if a good or service has a lot of substitutes that are easily available, people will switch more to these substitutes when the price of the good rises

The number of substitutes a good has depends on how broad we define a good: − Alcohol: very few substitutes, relatively inelastic (not so price sensitive)

− Beer: more substitutes, less inelastic (more price sensitive)

Question 4

What determines the price elasticity of demand?

Answer 4

• Income: when a consumer spends a large fraction of their income on a specific good, a price increase will cause a higher decrease in demand for the good − Salt: very few substitutes, but also, the fraction of income spent on salt is very small hence relatively inelastic (not so price sensitive)

− Mortgage: fraction of income is usually quite high, if the price increases (interest rates) people are likely cut down demand and rent instead

• Time: Adjusting to price-changes takes time … elasticity tends to increase as time passes. E.g. fossil fuels

Question 5

How is the price elasticity of demand related to consumer expenditure?

Answer 5

Total consumer expenditure (TCE) = money consumers spend on a product TE = p · Q * TCE = Total Revenue (TR) for the firm selling the product

• The impact of a price increase and subsequent fall in demand on TCE and TR depends on the price elasticity of demand

Question 6

How do we measure elasticity?

Answer 6

• In reality, demand curves take on different slopes across different price ranges * This means we’re only able to estimate elasticity along the portion of an entire demand curve
  The elasticity of demand between two given points of a demand curve is referred to as the arc elasticity

Question 7

What does income elasticity of demand determine ?

Answer 7

income elasticity of demand determines the size of the shift in the demand curve as the result of changes in income

IϵD = percentage change in the quantity demanded/ percentage change in income

Note how the equation no longer measures elasticity in absolute terms

• If a 2% rise in income results in a 8% rise in demand: IϵD = 8%/2% = 4
• If a 2% rise in income results in a 10% decrease in demand: IϵD = −10%/2% = −5

Question 8

what is normal goods ?

Answer 8

Normal goods: where IϵD ∈ (0, 1) meaning that there’s a disproportional and smaller increase in demand as the result of an increase in income e.g. food and some clothe types

Question 9

what is luxury goods ?

Answer 9

Luxury goods: where IϵD > 1 meaning that there’s a disproportional and larger increase in demand as the result of an increase in income e.g. designer clothes, holidays

Question 10

what is inferior goods ?

Answer 10

• Inferior goods: where IϵD < 0 meaning there’s a decrease in demand (or constant demand) as the result of an increase in income e.g. public transport and Tesco branded items

Question 11

what is cross price elasticity of demand ?

Answer 11

The cross-price elasticity of demand measures the responsiveness of demand to changes in the price of another good

look at notes for the graphs