elasticities

PED definition

responsiveness of the quantity demanded of a g/s to a change in it’s price

elasticity values

• 0 → perfectly inelastic

• 0<x<1 → relatively inelastic

• 1 → unitary elastic

• 1<x<∞ → relatively elastic

• ∞ → perfectly elastic

PED on a straight line demand curve

• there are different PED values on a straight line demand curve.

• Midway point → PED = 1

• elasticity decreases as price falls

• (above elastic below inelastic)

PED determinants 

• substitutes → more substitutes + easier to purchase → more price elastic in demand

• habits → more addictive → more price inelastic in demand

• income → higher proportion of income spent on product → more price elastic demand

• time-period → longer time period → price elastic demand 

Applications of PED

• business pricing decisions

• governments’ taxation decisions

business pricing decisions - applications of PED

• objective → revenue maximisation

• PED is inelastic → businesses raise prices to raise revenue (fall in qt. sold will be more than compensated by the higher price per unit)

when is revenue maximised on demand curve

midway point, PED = 1

Government’s Taxation decisions - applications of PED

(look at graphs after)

governments target products that are relatively price inelastic if the objective is to raise more tax.

effect of tax on elastic + inelastic products

• inelastic demand - people keep buying g/S → high tax revenue

• elastic demand → people avvoid tax by not buying the g/s anymore

primary commodities vs manufactured goods

• primary commodities → mostly necessity goods (any product produced in primary sector) → relatively inelastic in demand (higher price fluctuation)

• manufactured goods → not necessities / a lot of substitutes → relatively elastic in demand

income elasticity of demand (YED)

the relative change in the quantity demanded in response to the relative change in income.

same formula %change quantity demanded / % change in income

income elasticity of demand (YED) values

• positive → normal goods

• negative → inferior goods

• relatively inelastic → necessity → small shift in demand curve

• relatively elastic → luxury → big shift in demand curve

engle curve - label

• A -  YED>1 → luxury

• B - YED<1 → necessity

• C - YED=0

• D - YED<1 → inferior 

applications of YED

• growth of industries

• structural economic changes

growth of industries - applications of YED

if producer that operates in an industry with a low + positive YED (e.g +0.5) the industry will grow but at a slower rate than those with YED bigger than 1(elastic)

structural economic changes - applications of YED

overtime as manufacturing + service sectors (elastic) grow at a faster rate than the primary sector they gain a large proportion of national income. 

PES definition

responsiveness of the quantity supplied of a g/s to a change in the market price of the g/s

Determinants of PES

• length of time to adjust input factors and output to changes in price

• mobility of factors of production - easier/faster resources can be moved from one process to another → Higher PES

• spare capacity

• ability to store stocks

• rate at which costs per unit increase - smaller the rate of increase of costs per unit the more able are producers to expand their qt. supplied in response to a small increase in price.

primary commodities + manufactured g/s - price elasticity of supply

• primary commodities - rel. price inelastic in supply due to taking time to grow/mine + higher scarcity

• manufactured g/s - rel. price elastic in supply due to being able to produce output faster

consequences of low PES + PED on primary commodities

• rel. inelastic

• big change in price → small change in qt. traded

• strong price fluctuations

consequences of high PES + PED on manufactured g/s

• rel elastic

• small changes in price → big change in qt. traded

• smaller price fluctuations