Week 4: Elasticity Flashcards
What is the price elasticity of demand?
A units-free measure of the responsiveness of the quantity demanded of a good to a change in its price, ceteris paribus
What does ceteris paribus mean?
All other influences on buying plans remaining the same
Why is elasticity independent of units of measurement?
a) Responsiveness cannot be measured by the slope of a demand curve because it is dependent on units.
b) The quantities demanded for the different goods and services being compared have unrelated units of measurement.
What is the formula for price elasticity of demand?
εD= %∆QD/%∆P
What is the midpoint method for calculating the percentage changes in QD and P?
%∆QD= ∆QD/Q ave and %∆P= ∆P/P ave
Why aren’t the initial values of P and QD used to calculate their percentage changes?
The measure of how quantity demanded responds to a change in price depends on if it increases or decreases even if the range is constant.
What is the point elasticity formula for calculating the price elasticity of demand?
εD= (∆QD/∆P) x (P/QD)
where ∆QD/∆P is the slope of the demand function
When is the price elasticity of demand classified as inelastic?
When the %∆QD is less than the %∆P and the absolute value of εD is less than 1
When is the price elasticity of demand classified as elastic?
When the %∆QD is greater than the %∆P and the absolute value of εD is greater than 1
When is the price elasticity of demand classified as unit elastic?
When the %∆QD is equal to the %∆P and the absolute value of εD is equal to 1
When is the price elasticity of demand classified as perfectly elastic?
When there’s an infinitely large %∆QD and a small %∆P and the value of the absolute value of εD is infinity
When is the price elasticity of demand classified as perfectly inelastic?
When there is no change in %∆QD and a change in %∆P and the absolute value of εD is 0
What are the factors that influence the price elasticity of demand?
- Closeness of substitutes- the closer the substitutes for a good, the more elastic the demand (narrowly defined goods and luxuries have a more elastic demand than broadly defined goods and necessities)
- Proportion of income spent on the good- the greater the income spent on a good, the more elastic the demand
- Time elapsed since price change- the longer the time elapsed, the more elastic the demand
What is the price elasticity of demand at, above, and below the midpoint of a linear demand curve?
a) At the midpoint, εD=1
b) Above the midpoint, εD=greater than 1
c) Below the midpoint, εD=less than 1
What are the effects of a price cut or price rise on total revenue when demand is elastic, inelastic, and unit elastic?
a) Elastic- price cut increases the quantity sold by a larger amount and increases total revenue; price rise decreases quantity sold by a larger amount and decreases total revenue
b) Inelastic- price cut increases the quantity sold by a smaller amount and total revenue decreases; prince rise decreases the quantity sold by a smaller amount and total revenue increases
c) Unit elastic- amount of price cut or rise is equal to the change in quantity sold so total revenue remains unchanged
What is the total revenue test?
A method of estimating the price elasticity of demand by observing the change in total revenue that results from a change in price
What is the income elasticity of demand?
A measure of the responsiveness of the quantity demanded for a good to a change in income, ceteris paribus
What is the formula for income elasticity of demand?
εM= %∆QD/%∆M
What is the point elasticity formula for calculating the income elasticity of demand?
εM= (∆QD/∆M) x (M/QD)
where ∆QD/∆M is the slope of the demand function
What is the income elasticity of demand of a normal good classified as elastic and inelastic, and an inferior good?
Normal good when εM > 0 (positive)
a) Elastic- εM > 1, income and fraction spent rises (luxury)
b) Inelastic- εM < 1, income rises but fraction spent falls
Inferior good when εM < 0 (negative), income rises but fraction spend falls
What is the cross price elasticity of demand?
A measure of the responsive of the quantity demanded for a good to a change in the price of a substitute or a complement, ceteris paribus
What is the formula for cross elasticity of demand?
εXP= %∆QD/%∆P of substitute or complement
What is the point elasticity formula for calculating the cross elasticity of demand?
εXP= (∆QD/∆P2) x (P2/QD)
where ∆QD/∆P2 is the slope of the demand function
What is the cross elasticity of demand for a substitute and a complement?
a) Substitutes- εXP is positive; the demand and the price of the substitute change in the same direction
b) Complements- εXP is negative, the demand and the price of the complement change in opposite directions
