Microeconomics: Elasticity

What is price elasticity of demand (PED)?

Elasticity of demand is how responsive the quantity demanded is for a good or service when price or income changes.

How is PED calculated?

What are the degrees of PED?

• PED > 1: Price elastic demand

• PED = 1: Unitary elastic demand

• PED < 1: Price inelastic demand

• PED = 0: Perfectly inelastic demand

• PED = ∞: Perfectly elastic demand

What are the determinants of PED?

1. Number and closeness of substitutes

2. Degree of necessity

3. Proportion of income spent on the good

4. Time period considered

What is the relationship between PED and total revenue?

• If demand is elastic (PED > 1), a price fall increases total revenue.

• If demand is inelastic (PED < 1), a price fall decreases total revenue.

• If demand is unitary elastic (PED = 1), total revenue remains unchanged.

Why is PED important for firms and governments?

• Firms use it to set prices and maximize revenue.

• Governments use it to predict tax impacts and revenue changes.

What is income elasticity of demand (YED)?

Income elasticity of demand refers to how responsive the quantity demanded is for a good or service when income of consumers changes. 

How is YED calculated?

What do positive and negative YED values mean 

• Positive YED = Normal goods (demand rises as income rises).

• Negative YED = Inferior goods (demand falls as income rises).

  

What’s the difference between necessities and luxuries

• Necessities: Income inelastic (YED < 1).

• Luxuries: Income elastic (YED > 1).

What is price elasticity of supply (PES)?

Price elasticity of supply refers to how responsive the quantity supplied is for a good or service when price changes

How is PES calculated?

What are the degrees of PES?

• PES > 1: Elastic supply

• PES = 1: Unit elastic supply

• PES < 1: Inelastic supply

• PES = 0: Perfectly inelastic supply

• PES = ∞: Perfectly elastic supply

What are the determinants of PES?

1. Time period (more time → more elastic)

2. Mobility of factors of production

3. Unused capacity

4. Ability to store stocks

5. Rate at which costs rise