Economics HL: Elasticities

Elasticities

PED Definition

PED is a measure of responsiveness of the quantity demanded of a good with respect to a change in the price of the good.

0 < PED < 1

Relatively inelastic demand

PED=1

Unit elastic demand

PED > 1

Relatively elastic demand

Inelastic

Percentage change in quantity demanded is lower than percentage change in price

Elastic

Percentage change in quantity demanded is higher than the percentage change in price.

Unitary Elastic

Percentage change in quantity demanded is exactly proportional to percentage change in price

Perfectly Inelastic Demand

PED=0, quantity demanded is the same even if price changes

Perfectly Elastic Demand

PED= infinity, quantity is infinite at price P, but 0 at any other price.

Unit elastic

PED=1, goos show the same proportional response to change in price. 

Why PED varies along the straight line demand curve?

• values of PED for a normal demand curve will fall as the price falls

• at higher prices & lower quantity (top of curve), percentage change in Qd is greater than percentage change in P

• At lower price and higher quantity (bottom of curve), percentage change in Qd is less than percentage change in P.

How can total revenue be increased if PED is elastic?

Lowering the price of the product

How can total revenue be increased if PED is inelastic?

Increasing the price of the product

Determinants of PED

• Availability & closeness of substitutes

• Time period being considered

• Proportion of income spent on goods

Availability & closeness of substitutes

More substitutes, more elastic.
Less necessary, more elastic

Time period being considered

Longer time period, more elastic
Short run, inelastic

Proportion of income spent on goods

Small proportion of income spent, inelastic
Large proportion of income spent, elastic

Income Elasticity of Demand (YED)

YED measures the relative sensitivity of a change in the quantity of a good with respect to a change in people’s income.

What does YED signs indicate?

If it’s positive, it’s a normal good.
if it’s negative, it’s an inferior good.

Normal good

As income increases, demand increases.

Income elastic good

quantity demanded rises proportionately more than an increase in income.
YED > 1
Luxury goods

Income Inleastic Good

quantity demanded is proportionately less than the increase in income.
0 < YED < 1
Necessity Goods

Inferior Goods

Negative PED
Qd falls as income rises
Consumers switch their expenditure

Engel Curve

Shows a continuum: at very low income levels a good may be luxury; as income increases it becomes a necessity and finally at high income levels, it becomes inferior.

Price Elasticity of Supply (PES)

A measure of responsiveness of firms to increase the quantity supplied on the market due to a change in price.

Perfectly Inelastic Supply

PES=0
a change in price willl not affect the quantity supplied

Relatively Inelastic Supply

0 < PES < 1

Unit Elastic

PES = 1

Relatively Elastic Supply

PES > 1

Perfectly elastic supply

PES = infinity
a change in price of product will affect quantity supplied.
quantity is infinite at price P, but 0 at any other price.

Primary Commodities

Natural raw materials that are sold as they are found in nature, often unprocessed.

Manufactured Goods

goods produced by labour usually working together with capital as well as raw materials

Determinants of PES

• Mobility of FOP

• Passage of time

• Unused capacity

• Rate of cost increase

• Ability to store stocks

Mobility of FOP

If FOP’s can move quickly & easily, supply is more elastic

Passage of time

short term, inelastic supply
long term, elastic supply

Unused capacity

if producers have spare capacity, supply is more elastic

Rate of cost icrease

If costs of producing extra output increase rapidly, then supply will be inelastic

Ability to store stocks

if producers can store stocks and keep them for a long time, supply is elastic.