BUSINESS ECONOMICS LECTURE 3 - Elasticity and Government Intervention

Vocabulary flashcards covering key elasticity concepts (PED, cross-price and income elasticity), substitutes/complements, arc elasticity, and government tools (taxes, subsidies, price controls).

Price Elasticity of Demand (PED)

The responsiveness of quantity demanded to a change in price; PED = %ΔQD / %ΔP (or (ΔQD/QD) ÷ (ΔP/P)); PED is negative for a downward‑sloping demand.

Elastic

PED < -1; quantity demanded responds more than the price change.

Inelastic

-1 < PED < 0; quantity demanded responds less than the price change.

Unit Elastic

PED = -1; percentage change in quantity demanded equals the percentage change in price.

Arc Elasticity (Mid‑Point Method)

A method to measure elasticity on a linear demand curve using midpoints: PED = (ΔQ / Q̄) ÷ (ΔP / P̄), where Q̄ and P̄ are the midpoints.

Cross-Price Elasticity of Demand (XED)

The responsiveness of quantity demanded of good i to a price change in good j; XED = (%ΔQDi) / (%ΔPj); can be positive or negative.

Substitute Goods

Two goods for which a price increase in one leads to an increase in the demand for the other (positive XED); e.g., tea and coffee.

Complement Goods

Two goods for which a price increase in one leads to a decrease in the demand for the other (negative XED); e.g., DVDs and DVD players.

Income Elasticity of Demand (YED)

The responsiveness of quantity demanded to a change in income; YED = (%ΔQD) / (%ΔIncome); positive for normal goods, negative for inferior goods.

Normal Goods

Demand rises with rising income; positive YED; includes luxury goods (YED > 1) and necessities (0 < YED ≤ 1).

Luxury Good

A normal good with YED > 1 (demand rises more than proportionally with income).

Necessity

A normal good with 0 < YED ≤ 1 (demand rises with income but less than proportionally).

Inferior Goods

Demand falls as income rises; negative YED.

Price Ceiling

A maximum price set by the government; can create shortages in the market.

Price Floor

A minimum price set by the government; can create surpluses in the market.

Direct Taxes

Taxes paid directly to the government by the person or organization on whom they are imposed.

Indirect Taxes

Taxes imposed on producers or goods, but the burden can be passed to consumers depending on elasticities.

Specific Tax

A fixed amount charged per unit of a good (per‑unit tax).

Ad Valorem Tax

A tax based on the value or price of a good (percentage of price).

Incidence of Taxation

How the burden of a tax is shared between buyers and sellers; depends on relative elasticities; typically heavier on the side with the more inelastic curve.

Subsidies

Government payments to producers that shift the supply curve to the right, lowering the market price and increasing quantity.