elasticity

elasticity

the ratio of percentage changes between dependent and independent variables

name the different types of elasticity

• price elasticity of demand (PED)

• price elasticity of supply (PES)

• cross price elasticity of demand (CPED)

• income elasticity (YED)

PED

quantifies the responsiveness of buyers to a change in price of a product or resource

PED is always…

positive when looking at the coefficient

why is PED coefficient negative

the demand curve is downward sloping

PED =

• % change in Q/% change in P

• 1/slope x P/Q

• P/Q x dq/dp

PED (mdpt. formula) =

change in P/change in Q x Pa + Pb/Qa + Qb

elastic demand

• Ed > 1

• a small percentage change in price leads to a greater percentage change in quantity

inelastic demand

• Ed < 1

• a greater percentage change in P leads to a smaller percentage change in Q

unit elastic demand

• Ed = 1

• the percentage change in price equals the percentage change in quantity

TR =

P x Q

what happens to TR when demand is elastic

• TR moves in the same direction as Q

• incentive to lower prices to increase TR

what happens to TR when demand is inelastic

• TR moves in the same direction as price

• incentive to raise prices to increase TR

axiom

a profit-maximising firm with positive marginal costs will perpetually operate in the elastic region of the demand curve

why is it better to produce in the elastic region of the demand curve

because making more items costs money

what are PED determinants

• available substitutes

• definition of market boundaries

• proportion of income expanded

• necessity vs luxury goods

• time period

PES

quantifies the responsiveness of producers to variations in market price

PES =

% change in Q/% change in P

name the determinants of PES

• access to resources

• spare capacity

• time (long run or short run)

• inventories

elastic supply

Es > 1

inelastic supply

Es < 1

unit elastic supply

Es = 1

income elasticity

measures the responsiveness of Qd to a shift in consumer income

YED =

% change in Qd/% change in Y

normal goods

• Ey > 0

• when people earn more, they buy more of these goods

necessity goods

• 0 < Ey < 1

• you buy more, but not that much more

luxury good

• Ey > 1

• you buy a lot more of that good when average income increases

inferior good

• Ey < 0

• when people earn more, they actually buy less of these goods

CPED

measures how the demand for good A reacts when the price of good B changes

substitutes

• positive

• the two goods are competitors

complements

• negative

• the two goods are bought together

independent goods

• Eab = zero

• there is no relationship between the goods

what happens when government puts a tax on a product

it drives a wedge between the price the consumer pays and the money the business actually gets to keep

who gets the burden of tax

whichever group that is the most inelastic (consumers or producers)

if demand is elastic and supply is relatively inelastic, who bears the burden of tax

producers

if supply is elastic and demand is relatively inelastic, who bears the burden of tax

consumers

if both demand and supply are elastic/inelastic who bears the burden of tax

both pay equal tax