Unit 2, Elasticities and Surplus

Price elasticity of demand (PED)

Measures the responsiveness of the quantity demanded for a product following a change in the price of the product. Calculated as the percentage change in quantity demanded divided by the percentage change in price

Factors affecting PED

SPLAT, Substitutes (no.), Percentage of Income, Luxury/Necessity, Addictive / Habit Forming, Time Period

Elasticity

A numerical measure of the responsiveness of one variable following a change in another variable, ceteris paribus

elastic

where the relative change in quantity demanded is greater than the change in price, income, or the prices of substitutes and complements

inelastic

where the relative change in quantity demanded is less than the change in price, income, or the prices of substitutes and complements

price elastic

where the relative change in quantity demanded is greater than the change in price, PED > 1

price inelastic demand

where the relative change in quantity demanded is less than the change in price, PED < 1

perfectly price inelastic demand

when a change in price has no effect on the quantity demanded, PED = 0

perfectly price elastic demand

where all that is produced is sold at a given price, PED = ∞

unit price elasticity of demand

where the change in price is relatively the same as the change in quantity demanded, PED = 1

Income elasticity of Demand (YED)

A numerical measure of the responsiveness of the quantity demanded for a product following a change in income, calculated as percentage change in quantity demanded divided by percentage change in income

Factors affecting YED

NAPT, nature of the good (necessity vs. luxury), availability of substitutes, proportion of income spent on the good, and time period considered. 

Normal Good

A good for which demand increases as consumer income rises, YED>0

Inferior good

A type of good for which demand decreases as consumer income rises, YED<0.

Necessity good

A type of normal good for which the quantity demanded is unlikely to change when income changes, YED is close to zero

Superior / luxury good

A type of normal good for which demand increases more than proportionately as income rises, YED>1.

Maximise total revenue with elastic PED

Lower price

Maximise total revenue with inelastic PED

Raise price

Cross elasticity of demand (XED)

a numerical measure of the responsiveness of the quantity demanded for one product following a change in the price of another product, calculated as percentage change in quantity demanded of good A divided by percentage change in price of good B

Factors affecting XED

PDA, the proportion of income spent on the good, the degree of necessity of the good, and the availability of substitute goods

Substitutes

Goods with a positive XED

Complements

Goods with a negative XED

Value of PED

Can be used to explain price variations in a market, the impact of changing prices on consumer expenditure and sales revenue, and the effects of changes in indirect taxes on government income

Value of YED

Can be important for firms and governments in forecasting the future demand for a whole range of goods and services

Value of XED

Allows firms to understand the impact of other firms pricing strategies and allow firms to identify those products that are most complementary to help introduce improved pricing structures

Price elasticity of supply (PES)

a numerical measure of the responsiveness of the quantity supplied to a change in the price of a product, calculated as the percentage change in quantity supplied divided by the percentage change in price

Price elastic supply

When the quantity supplied responds more than proportionately to a change in price, PES > 1

Price inelastic supply

When the quantity supplied responds less than proportionately to a change in price, PES < 1

Factors affecting PES

BRITS, Barriers to Entry, Raw Materials, Inventory, Time, Spare Capacity

Value of PES

Can help to explain the varying speed and ease with which businesses can respond to changing market conditions

Consumer surplus

The difference between what consumers are willing to pay for a good or service and the market price they actually pay. It measures the economic benefit to consumers.

Producer surplus

The difference between the price at which producers are willing to supply a good or service and the market price they actually receive. It measures the economic benefit to producers.

Consumer surplus on a graph

represented as the area between the demand curve and the market price level, up to the quantity sold.

Producer surplus on a graph

represented as the area above the supply curve and below the market price, up to the quantity sold.