economics (elasticities)

price elasticity of demand (PED)

measures how much demand for a product will change if the price changes

PED formula

inelastic demand

IF PED IS LESS THAN 1
when a % change in price results in a lower % change in demand
increase in price will cause an increase in total revenue
decrease in price will cause a decrease in total revenue

elastic demand

IF PED IS GREATER THAN 1
when a change in % in price results in a greater change in % demanded
firm should NOT raise their prices because a rise in price would result in less revenue
firms should lower their prices

unit elastic demand

IF PED IS = 1
when a % change in price results in an equal % change in demand
a change in price will result in NO change in total revenue$

perfectly inelastic demand

IF PED IS = 0
when a change in price results in NO change in quantity demanded
people that need it need it

determinants of PED

S- substitutes
P- proportion of income
L- luxury or necessity?
A- addictive
T- time

substitutes (PED)

determinant of PED
The more substitutes a good has, the more elastic demand is
AND the closer the substitute is, the more elastic demand will be.

degree of necessity (PED)

determinant of PED
if a good is a need, then most/many consumers will continue to purchase the good even if prices go up
could be addictive substances

proportion of income spent (PED)

determinant of PED
the larger the portion of your income you spend on a good, the more elastic demand will be
luxury goods are very elastic
if a good or service that is a small portion of your income increases in price you will hardly notice

time (PED)

determinant of PED
the longer a consumer takes in making a purchase, the more elastic demand will be

income elasticity of demand (YED)

measure of the responsiveness of demand to a change in incomes

YED formula

Positive YED

it is a normal good
demand will increase as income increases

income-inelastic demand

IF YED IS BETWEEN 0 AND 1
good is a necessity
demand will change very little

income-elastic demand

IF YED IS GREATER THAN 1
good is a luxury or service
demand will rise noticeably if incomes rise

inferior good

IF YED IS NEGATIVE
demand decreases as incomes increase
demand will increase as incomes decrease

Engel Curve

shows the relationship between demand and income over time

price elasticity of supply (PES)

measure of how much supply will change if prices change

PES formula

perfectly inelastic supply

IF PES IS ZERO
change in price will have no effect on supply

inelastic supply

IF PES IS BETWEEN 0 AND 1
change in the price of a product leads to less change in supply

elastic supply

IF PES IS GREATER THAN 1
change in price will lead to a larger increase in supply

perfectly elastic supply

IF PES IS INFINITY
any change in price will result in no supply
like wheat or other commodities on the world market

determinants of PES

T- time
R- rate of cost increase
U- unused capacity
M- mobility of factors of production
A- ability to store

time (PES)

determinant of PES
it takes time to reallocate resources and increase supply
over time, if there has been an increase in prices supply will become more elastic

mobility of factors of production (PES)

determinant of PES
the easier it is to change from one line of production to another, the more responsive supply is to a change in price
manufactured goods are more elastic than agricultural products
primary commodities and heavy industrial goods are inelastic supply

unused capacity (PES)

determinant of PES
if a firm can increase production without having to expand its plant size and capital then they can quickly increase supply

ability to store (PES)

determinant of PES
if a firm can store their goods when demand is low, then they could bring them out of storage when demand increases
if the good is perishable then firms cannot keep it in stock and increase supply when demand shifts

rate at which costs increase (PES)

determinant of PES
if the costs of increasing production are high, supply will be inelastic
if the costs of increasing production are low, supply will be elastic

PES for manufactured goods

PES values for manufactured goods are generally higher than for commodities
machinery often can be repurposed to respond to a change in demand

PES for primary commodities

all natural resources
PES values are very low
it takes months, if not years to change supply
land and resources are limited
environmental destruction, global warming further limits commodities

Sectors of the economy

primary, secondary, tertiary

primary sector

commodities/natural resources
YED values tend to be greater than 1

secondary sector

manufactured goods
YED values tend to be greater than 1

tertiary sector

services
YED values tend to be less than 1

developing countries

rely primarily on its primary sector
low PES values make it hard to increase output when prices rise
low YED values mean that as incomes rise, developing countries do not benefit greatly

developed countries

large tertiary sector
benefit as incomes rise in the world
hurt the most when there is a recession

importance of YED for firms

firms benefit from knowing if they will thrive or struggle in a recession or during economic growth