Economics Semester 1

Price Elasticity of Demand

The responsiveness of quantity demanded to a change in price of a product. It is a measure of how sensitive buyers are to a change in price.

PED = 0

- Perfectly INELASTIC

- Change in P will not change Qd

- Usually necessary for survival

PED < 1

- Relatively INELASTIC

- If P⬆️ by 1% Qd will ⬇️ by <1%

- Less sensitive to change in P

PED = 1

- Unitary ELASTIC

- The same change will occur on both axis

PED > 1

- Relatively ELASTIC

- If ⬆️ in P by 1% Qd will ⬇️ by > 1%

- More sensitive to ⬆️ in P

PED = Infinity

- Perfectly ELASTIC

- Any ⬆️ in P consumers will stop buying

- Usually goods with perfect substitues

Determinants of PED

- Availability of substitutes

- Proportion of income spent

- Necessity or luxury?

- Time

- Definition of a market

PED Determinant - Availability of Substitutes

- The greater the substitute the more elastic

- Demand for good that have few substitutes are inelastic

- More sensitive to change in price (can switch to other products)

PED Determinant - Proportion of income spent

- Little of our income = more inelastic

- Lots of income = more elastic

PED Determinant - Necessity or Luxury?

- If necessity = inelastic

- If luxury = more elastic

PED Determinant - Time

- How long consumers have to shop around / delay purchase

- More time = more elastic

PED Determinant - Definition of a Market

- Broadly defined market = more inelastic

- Narrowly defined market = more elastic

TR: P⬆️ - ELASTIC

⬆️ in P = ⬇️ in TR

- P and TR move in opposite directions

TR: P⬇️ - ELASTIC

⬇️ in P = ⬆️ in TR

TR: P⬆️ - INELASTIC

⬆️ in P = ⬆️ in TR

TR: P⬇️ - INELASTIC

⬇️ in P = ⬇️ in TR

Price Elasticity of Supply

A measure of the responsiveness of quantity supplied of a good to a change in the price of that good.

PES = 0

- Perfectly INELASTIC

- A change in P will not change Qs

PES < 1

- Relatively INELASTIC

- A ⬆️ in P of 1% will result in < 1% ⬆️ in Qs

PES = 1

- Unitary ELASTIC

- P change = Qs change

PES > 1

- Relatively ELASTIC

- a ⬆️ in P of 1% will result in > 1% change is Qs

PES = Infinity

- Perfectly ELASTIC

- Eg. minimum wage

Price ELASTIC goods in SUPPLY

Sellers can easily and quickly expand supply in response to a change in P. Eg. manufactured goods

Price INELASTIC goods in SUPPLY

Sellers can not quickly and easily expand supply. Eg. Agricultural goods

Determinants of PES

- Time

- Ability to store inventory

- Nature of industry

PES Determinant - Time

- If producers can respond quickly to change in P, elastic

- If goods take a long time to produce, inelastic

PES Determinant - Ability to store inventory

- Goods that can be stored are more elastic than perishable goods

- Producers of storable goods can be flexible with their supply

PES Determinant - Nature of industry

- Agricultural goods are inelastic, manufactured is elastic

- Farmers need to wait until next growing season, manufactured goods supply can be easily adjusted depending on the market

Consumer surplus

The difference between the consumer’s willingness to pay and the actual price payed

Marginal benefit

Additional benefit gained through consuming and extra good or service

Producer surplus

the difference between the lowest price a firm would be willing to accept for a good and the price it actually receives

Total surplus

A measure of net benefits to society for the production and consumption of a good

DWL

An avoidable decrease in total surplus

Price ceiling

Legislated maximum price producers are allowed to charge

Price floor

Legislated minimum price producers are allowed to charge

Subsidy

A cash payment from governments to businesses to encourage the production of goods/services

Market failure

When resources are not allocated efficiently

Market power

The ability of a firm to raise and maintain price above market value

Causes of market power

Patent, controlling scarce resources, predatory pricing

Policy options to influence market power

1. Competition policy and regulation

2. Market deregulation

3. Legislation

Competition policy and regulation

- Strengthen competition laws

- Empowers Aus copetition & consumer commision to investigate and stop anticompetitive behaviour

- Encourages competition by promoting market entry

Market deregulation

- Deregulate certain sectors to encourage new entrants

- Promotes privatisation (selling government owned businesses to private sectors)

Legislation

- Required to address market concentration

- Required to prevent companies from engaging in anticompetitive behaviour

Externality

An unintended community consequence / side effect that causes a DWL

Policy options to correct externalities

1. Taxes

2. Subsidies

Taxes

- A fee that is charged by the government on a product

- Market will respond by ⬆️P and ⬇️Q, DWL is removed

Subsidies

- Cash payments from the government to encourage production of goods / services

- Market responds by ⬇️P and ⬆️Q, DWL is removed