Week 4: Elasticity Flashcards
<p>Define price elasticity of demand and how it can be calculated</p>
<p>the responsiveness of the quantity demanded to changes in price, of greater importance to firms</p>
<p>Ed=(% change in Qd)/(% change in price)</p>
<p>Describe the categories of Ed</p>
<h4>elastic demand</h4>
<ul> <li>when the percentage change in quantity demanded is greater than the percentage change in price (i.e. consumers are quite responsive to changes in price).</li> <li>Ed > 1 (in absolute values)</li></ul>
<h4>inelastic demand</h4>
<ul> <li>when the percentage change in quantity demanded is less than the percentage change in price (i.e. consumers are relatively unresponsive to changes in price)</li> <li>Ed < 1</li></ul>
<h4>unit elastic demand</h4>
<ul> <li>when the percentage change in quantity demanded is equal to the percentage change in price (consumers respond proportionately to changes in price)</li> <li>Ed = 1</li></ul>
<p>Describe the determinant of Ed</p>
<h4>1.Availability of close substitutes</h4>
<ul> <li>the more close substitutes there are, the more people will ‘switch’ if you raise your price i.e. Dominos pizza versus Pizza Hut pizza</li></ul>
<h4>2.Time</h4>
<ul> <li>the more time that passes, the greater the opportunity to find suitable alternatives – in the short term Ed is more inelastic as it takes time to adjust spending and find suitable alternatives i.e. moving towards gas or electric if price of petrol increases</li></ul>
<h4>3.Necessities vs. luxuries</h4>
<ul> <li>by definition luxuries we can do without, hence more responsive to changes in price while necessities are less responsive i.e. bread inelastic, demand for Tiffany watches elastic.</li></ul>
<h4>4.Definition of the market</h4>
<ul> <li>the broader the definition of the market, the less elastic i.e. demand for Samsung TVs more elastic than overall demand for TVs as more substitutes</li></ul>
<h4>5.Share of income/budget spent on good</h4>
<ul> <li>the smaller the fraction a good takes up the less elastic demand will be i.e. increase in the price of sugar versus a 50% rise in the price of cars.</li></ul>
<p>What is the midpoint method of calculating Ed?</p>
<p>used if given actual change</p>
<p></p>
<p>Describe perfect elasticity</p>
<ul> <li>demand curve is horizontal</li> <li>if price ↑ even slightly above its current equilibrium, the QD will fall to zero</li></ul>
<p>Describe perfect inelasticity</p>
<ul> <li>demand curve is vertical</li> <li>the same quantity of the good will be demanded regardless of what the price is (that is, % Δ Qd = 0) i.e. insulin, a vital good</li></ul>
<p>Describe total revenue and elasticity</p>
<ul> <li>Ed allows firms to see how changes in price will affect a firm’s total revenue (one person’s expenditureàfirm’s revenue – can use this to view consumer’s spending on a product as well)</li></ul>
<p>TR = Price x Quantity</p>
<ul> <li>i.e. when price decreases (i.e. P↓ and QD ↑) <ol> <li>Sellers earn less revenue on each unit sold (loss of TR)</li> <li>Sellers earn more revenue as more units are sold (gain in TR).</li> </ol> </li></ul>
<ul> <li>therefore the overall change in TR is the net result of these two effects</li></ul>
<p>linear demand curve: elasticity varies along this curve</p>
<ul> <li>if demand is elastic, then a decrease in price will <u>increase</u> total revenue</li> <li>if demand is inelastic, a decrease in price will <u>decrease</u> total revenue, decrease in Qd is greater than benefit from increase in price</li> <li>if demand is unit elastic, then there is no change in total revenue</li></ul>
<p>Describe income elasticity of demand</p>
<p><em>def.</em>: responsiveness of demand to a change in income</p>
<p>e.g. if income increases</p>
<ul> <li>if demand decreases, Ei < 0, good is inferior</li> <li>if demand increases Ei > 0, good is normal</li></ul>
<p>Describe cross elasticity of demand</p>
<p>.: the responsiveness from a change in the price of one good, on the demand for another good</p>
<ul> <li>Ex > 0: goods are substitutes</li> <li>i.e. if the price of apples (good B) falls, people buy more apples, and therefore fewer oranges (good A)</li> <li>Ex < 0: goods are complements</li></ul>
<p>i.e. if the price of pasta (good B) falls, people buy more pasta, and therefore more pasta sauces</p>
<p>Describe price elasticity of supply and its extremes</p>
<p>def.: measure of the responsiveness of the quantity supplied to a change in price</p>
<ul> <li>perfectly inelastic (Es=0) <ul> <li>supply curve is vertical</li> <li>generally short run i.e. production level in factory may be set on a weekly basis and the same Qs regardless of changes in prices during that week</li> <li>also for goods that are finite in supply i.e. Picasso paintings</li> </ul> </li> <li>perfectly elastic (Es= ∞) <ul> <li>supply curve is horizontal</li> <li>often in mass production when marginal cost is constant</li> </ul> </li></ul>
<p>What are determinants of Es?</p>
<ol> <li>Time</li></ol>
<ul> <li>the longer the time frame, the more chance firms have to adjust the production of their good. Therefore, the longer the time frame, the more elastic supply will be</li> <li>i.e. supply of crops fixed once planted, but can be increased or decreased next season</li></ul>
<ol> <li>Cost of inputs</li></ol>
<ul> <li>how easily are inputs transferable / substitutable to other types of production? The easier it is, the more elastic will supply be i.e. unskilled labour to pick oranges</li> <li>in general, if marginal costs rise significantly as supply increases, then supply will be less elastic</li></ul>
