Week 3 - Elasticity Flashcards
Price elasticity of demand (ε)
The measure of how much quantity demanded responds to changes in price.
Price elasticity of demand formula (arc elasticity)
ε = | %Δ Quantity demanded / %Δ Price |
It is always positive
Values of price elasticity of demand
If ε > 1, demand is elastic - consumers are responsive to price changes.
if ε < 1, demand is inelastic - consumers are unresponsive to price changes.
if ε = 1, demand is unit elastic
Perfectly elastic demand
ε = ∞. Demand curve is a straight horizontal line.
Even a small change in price causes a change in demand.
Perfectly inelastic demand
ε = 0. Demand curve is a straight vertical line.
Price does not effect demand.
Determinants of price elasticity of demand
Availability of substitutes - lots of substitutes will cause a high elasticity of demand.
Proportion of budget - more expensive items that occupy more of your budget tend to be more elastic than cheaper items.
Time - more time means consumers have more chance to change to substitutes or change their behaviour
Addiction/habits - Addictive or habitual goods tend to be inelastic.
Arc elasticity
Price elasticity of demand between two points on the demand curve
Point price elasticity
Price elasticity of demand at a particular point on the demand curve
Point price elasticity formula
|1/slope| × P/Q
Slope - gradient of a line
Cross price elasticity of demand (XED)
The percentage change in quantity demanded of a good in response to a 1% change in price of another good.
Cross price elasticity of demand formula
ΔQx / ΔPy × Py / Qx
Values of cross price elasticity of demand
If XED is positive, the goods are substitutes
If XED is negative, the goods are complements
Income elasticity of demand
percentage change in quantity demanded in response toa 1% change in consumers income.
Income elasticity of demand formula
%Δ Quantity demanded / %Δ consumer income
Values of income elasticity of demand
Income elasticity of demand is positive for normal goods
Income elasticity of demand is negative for inferior goods
How is prices and expenditure effected by elasticity of demand
When ε > 1, changes in price and expenditure move in opposite directions - increase in price means decrease in expenditure.
When ε < 1, changes in price and expenditure move in the same direction - increase in price means increase in expenditure.
Price elasticity of supply (Es)
The measure of how much quantity supplied responds to changes in price
Price elasticity of supply formula (arc elasticity)
Es = %Δ Quantity supplied / %Δ Price
It is always positive
Values of elasticity of supply
If ε > 1, supply is elastic - suppliers are responsive to price changes.
if ε < 1, supply is inelastic - suppliers are unresponsive to price changes.
if ε = 1, supply is unit elastic
Determinants of price elasticity of supply
Flexibility of inputs - how easy it is to source inputs to increase supply
Mobility of inputs - how easy it is to transport inputs
Ability to produce with substitute inputs
Time - can solve problems with flexibility/mobility/substitution of inputs in the long run.
