Economics - Test 2 Prep - Income elasticity, supply elasticity, cross-price elasticity, tax and supply elasticity

Test 2 -preperation

price elasticity

is the concept taht meausres the responsiveness of quantity ti a chnage in price. the law of demand states that there is a negative relationship between price and quantityt

formula: PED

per cent chnage in quantity demanded / per cent change in price.

if the value is greater than 1, then demand is said to be price elastic

if the value is less than 1,then demand is asid to be price inelastic

exapnded fromula: PED

(change in quantity / quantity) / (chnage in price/price)

(change in quantity / quantity) * (price/ chnage in price)

formual: midpoint formula

PED = (chnage in quantiyt/q avergage) * (price avergage/ change in price )

ED = 0

demand is said to be perfectly inelastic when price changes, and quantuty does not chnage. on teh grpah this would be a. striaght line/ perfectly vertical. an example would be a ood with no substitutes

ED = infintiy

demand is sadi to be perfectly elastic when price increase adn quantity demanded falls to zero. the demand curve is perfeclty horizonatal. a good example would be a good with perfect substitutes.

what are inelastic goods/ demand

goods with inelastic demands are necessities and habit-forming goods and typcially have ver yfew substitutes

what are elastic goods / demand

goods with elastic demand are non-essential goods + services and tend to have ready made substitutes

formula: avergae quanitty

(Q2 + Q1) / 2

formula: avergae price

(P2 + P1) / 2

Total revenue

total reveuenue is teh amount of money paid by buyers and received by sellers.

TOTAL REVENUE = PRICE MULTIPLIED BY QUANITYT

A change in price can impact TR = and the answer depends on the price elastiicty of demand.

if demand is elastic and price increases, then quantity demanded will fall by a bigger proportion - this means that TR must decrease.

If demand is elastic and price decreases, then quantity demanded will increase by a bigger proportion - this means that TR must increase.

if demand is inelastic and price increases, then quanityt demanded will fall by a smaller proportion. - this means that TR must increase

if demand is inelastic and price decreases, the n quanityt demanded will increase by a smaller proportion - this means that total revenue must decrease.

what would happen to TR if demad was unitary elastic (Ed = 1)

if the price increases, TR will not chnage

If the price decreases, TR will not chnage

this is because price and quanitty will chnage by teh same proprtion

elasticity along a demand curve

as you move down along a linear demand curve, the price elasticity of demadn falls.

at the top of the D curve where quanitty is zero, elasticity is infitnite

at the bottom of the demand curve, where the price is zero, elasticity is zero

at the midpoint of teh demand curve, elasticity is equal to one.

price discrimination

firms can use info about price elasticity to increase their revenue. price discrimination is yeh pracrice where firms sell teh same G+S to differnet customers based on tehir price elasticity.

ability to segment the market (by age or gender); a different elasticity for each group; no arbitrage.

price discrimination - hairdressers

If a seller can identify which customers have elastic demand and which customers have inelastic demand, they can increase their revenue by charging different prices.

FOR EXAMPLE - hairdressers can separate male customers from female customers

The group with the more inelastic demand would et he females. So the seller should increase the price to females, and TR will increase.

They should reduce the price to males because their demand is relatively inelastic, and TR will also increase.

main determinats of price elasticity

1. availability of substitutes - goods with many close subsitutes are more elastic tahn goods with less substitutes

2. necessity or non-essential goods - goods that are necessary are more inelastic while non-essnrtial goods are more elastic.

3. proportion of icnome spent - relatively expensive goods are more elastic and goods taht are cheaper are relatively mre inelastic.

4. defintion of market - the demand fir a vroiad category of goods is more inelastic than goods with which are of a specific btrand.

5. time - demand will be relatively more elasti the lon ger the period consumers have to adjust to a price gcnage —> this is because consumers will find it easier to swithc to a subsitute.

   

price leasticity of supply

meausres how much teh quanityt supplied of a good chnages in repiosnse to a change in its price

formual: price elasticity of supply

1. Measuring price elasticity of supply:

   1. Price elasticity (S) = % change in Qs / % change in price 

   2. If the value is greater than 1, then the supply is said to be price elastic

   3. If the value is less than 1, then the supply is said to be price inelastic 

formula:cprice elastiicyt of uspply —> expanded

Expanding the elasticity formula to:

Es = change in quantity/quantity divided by change in price/price

Or

Es = change in quantity/quantity multiplied by price/change in price

main determinants of price elasticiyt of supply

1. time - as time increases, supply will be more elastic

2. nature of teh industry - manufactered foods is more elastic (supply) tahn the supply of agricultural goods, which are relaticley inelastic due to the time it takes.

3. ability to store inventories / storage - if a producer can store its goods, supply will be relatively elastic.

the role of taxation and tax on inelaastic goods and elastic goods

The role of taxation is to raise revenue and regulate bad consumer habits. Taxation should be minimal to allow for maximum efficiency as taxation in general discourages production. 

Taxation on inelastic goods means demand is affected less and therefore jobs and investment in those industries are likely to continue. 

When a tax is imposed on elastic goods, demand drops sharply since consumers can easily switch to alternatives, causing producers to bear most of the tax burden. This results in lower tax revenue for the government and significant losses for businesses, making it an ineffective way to raise funds.

4o

predicting changes in price

it is possible to preduce how much price will chnage when their is a ngicen change in either demand and supply - as long as both teh price elasticity of demand and suppl yare known.

formula: % change in price

% change in price = % change in demand divided by (Ed / Es)

1. (Ed) - price elasticity of demand

2. (Es) - price elasticity of supply 

cross-rpice elasticity

cross-price elasticity (XED) measures hwo much teh quantity demanded of one good responds to ca chnage in the price of another good.

interpreting : XED - CROSS-PRICE ELASTICITY

1. positive XED (greater than 0): teh goods are substitutes. a price increase i none leads to an increase in demand fro teh other

2. negayive XED (Less than 0): the goods are complementary and a chnage in price icnrease in one decreases teh demand for the other.

3. XED = 0 : the goods are unrelated and price changes in one have little to no effect on the other.

formula: XED

 % change in quantity demanded for good A  /  %change in price of good B. 

price elasticity and taxes

describe the application of price elasticity of demand and supply to markets

PED IN MARKETS

• businesses set prices based on elasticity to maximise revenue

• Businesses use price elasticity of demand to set prices—raising prices for inelastic goods (like fuel) increases revenue, while elastic goods (like movie tickets) require competitive pricing. Governments use PED to decide tax policies, taxing inelastic goods to maximize revenue without drastically reducing demand.

PES IN MARKETS

•  Firms adjust supply based on how responsive their production is to price changes.

• Firms use price elasticity of supply to manage production—if supply is elastic, they can quickly increase output when prices rise (e.g., clothing), but if inelastic, production takes longer (e.g., housing). Governments use PES to plan subsidies and policies, supporting industries with low supply elasticity to prevent shortages.

  4o

explain the importnace of price elasticity of demand and supply for businesses and govt., including incidence of a tax and price discrimiantion

Tax Incidence:

• If demand is inelastic, consumers bear more of the tax burden.

• If demand is elastic, producers bear more of the tax burden.

Price Discrimination: 

• Businesses charge different prices to different groups based on PED (e.g., student discounts, peak vs. off-peak pricing).

Government Policies:

• Taxes on inelastic goods (e.g., alcohol, cigarettes) raise revenue.

• Subsidies on elastic goods (e.g., renewable energy) encourage consumption.

normal goods vs inferior goods

Normal goods have positive income elasticity, meaning demand increases with income, whereas inferior goods have negative income elasticity, meaning demand decreases with income.