Flashcards Economics: Elasticity of Demand and Supply

Elasticity

A term in economics used to measure the degree of responsiveness of one variable to the changes of another variable.

Own Price Elasticity of Demand (eD)

It refers to the measure of the degree of responsiveness of quantity demanded of a good to changes in the price of that good. This further explain how reactive the buyers in terms of amount purchased when the price of the product increases or decreases.

Unit Elastic Demand

The demand for a certain good is said to be price unit elastic, when proportional change in QD is matched by an equal proportional change in P, e.g., eD = -1.0.

When change in price of X brings about exactly proportionate change in quantity demanded of X the demand is unit elastic or elasticity of demand = 1, e.g. if price falls by 10% then, demand expands by 10%.

Clue: Equal percentage changes in price and quantity demanded.

Relatively Inelastic Demand

The demand for a certain good is said to be price inelastic, when quantity demanded is not very responsive to small changes in the price of the good or the proportional change in QD is less than the proportional change in P, e.g., eD = -0.5.

When change in price brings about less than proportionate change in quantity demanded, then demand is relatively inelastic or eD is less than 1, e.g. if price falls by 10% and demand rises by 5%.

Clue: Quantity demanded changes by a smaller percentage than price.

Relatively Elastic Demand

The demand for a certain good is said to be price elastic when quantity demanded is very responsive to small changes in the price of the good. The proportional change in QD is greater than the proportional change in P, e.g., eD = -2.5.

When change in price brings about more than proportionate change in quantity demanded, then demand is relatively elastic or eD is greater than 1, e.g. if price falls by 10% and the quantity demanded rises by 20%.

Clue: Quantity demanded changes by a larger percentage than price.

Perfectly Inelastic Demand

When change in price has no effect on quantity demanded, then demand is perfectly inelastic or eD is zero.

Clue: Price changes, but quantity demanded stays the same.

Perfectly Elastic Demand

When a slight change in price brings about infinite change in the quantity demanded, then demand becomes perfectly elastic. In this case elasticity of demand is infinity.

Clue: A tiny price change causes an infinite change in quantity demanded.

1. Unit Elastic Demand

2. Relatively Inelastic Demand

3. Relatively Elastic Demand

Types of Price-Elasticities of Demand discussed through the relationship between Total Revenue and eD.

TR = P × Q

Total Revenue (TR) refers to the product of price and the quantity demanded, where P = price and Q = quantity.

1. If change in price brings about change in quantity demanded in such a way that total outlay remains the same, then demand is unit elastic.

2. If change in price brings about a change in the quantity demanded in such a way that the total outlay goes on falling, then demand is relatively inelastic.

3. If change in price brings about a change in the quantity demanded in such a way that the total outlay goes on increasing, then demand is relatively elastic.

Relationship of Total Revenue and eD

1. If |eD| > 1

2. If |eD| < 1

3. If |eD| = 1

Relationship between Elasticity, Price Change, and Effect on Total Revenue (TR).

1. If |eD| > 1: Increase in Price - Decrease in TR; Decrease in Price - Increase in TR.

2. If |eD| < 1: Increase in Price - Increase in TR; Decrease in Price - Decrease in TR.

3. If |eD| = 1: Increase or Decrease in Price - TR remains unchanged.

Relationship between Elasticity, Price Change, and Effect on Total Revenue (TR).

Income Elasticity of Demand (h)

Measures the degree of responsiveness of quantity demanded of a good to changes in the level of income of consumer. This further explain how reactive the buyers in terms of amount purchased when their income increases or decreases.

1. Percentage change in quantity demanded

2. Percentage change in Income

Mathematical Formula of Income Elasticity of Demand

1. Coefficient of income elasticity of demand

2. Quantity demanded of a good per unit time

3. Income of the consumer

4. Symbol for change

5. Percent

Symbols and their meanings in the Income Elasticity of Demand formula (h, QD, I, Δ, %).

1. If h > 0

2. If 0 < h < 1

3. If h > 1

4. If h < 0

Classification of Goods and Their Income Elasticities

Clue: Positive = normal; negative = inferior.

Normal Good

If h > 0 (e.g., h = 2), then the good is normal good.

Necessity

If 0 < h < 1 (e.g., h = 0.8), then the good is normal and is considered a necessity, e.g., rice and other basic goods.

Clue: Income increases, but demand increases proportionately less.

Luxury

If h > 1 (e.g., h = 1.5), then the good is normal and is considered a luxury, e.g., appliance, jewelry, etc.

Clue: Demand increases proportionately more than income.

Inferior Good

If h < 0 (e.g., h = −0.75) then the good is inferior good, e.g. salt, "tuyo" or "dilis", or sugar.

Cross-Price Elasticity of Demand (qXY)

Measures the degree of responsiveness of quantity purchased of one good as the price of another good changes.

1. Percentage change in quantity demanded of good X

2. Percentage change in the price of good Y

Mathematical Formula of Cross-Price Elasticity of Demand

1. Coefficient of cross price elasticity of demand of X for Y

2. Quantity demanded of good X per unit time

3. Price of good Y per unit time

4. Symbol for change

5. Percent

Symbols and their meanings in the Cross-Price Elasticity of Demand formula (qXY, QDX, PY, Δ, %).

1. If qXY > 0

2. If qXY < 0

3. If qXY = 0

Relationship between Goods X and Y

Clue: Positive = substitutes; negative = complements; zero = independent.

Substitutes

If qXY > 0 (e.g., qXY = 1.5), then X and Y are substitutes.

Complements

If qXY < 0 (e.g., qXY = −0.5), then X and Y are complements.

Independent Goods

If qXY = 0 (e.g., qXY = 0), then X and Y are independent of each other.