Elasticities

price elasticity of demand

how responsive the change in QD is to a change in price

calculating PED

0 PED value

• perfectly inelastic

• QD is completely unresponsive to the change in price

• this is usually a very theoretical value

0-1 PED value

• relatively inelastic

• % change in QD is lower than the % change in price

1 PED value

• unitary elasticity

• % change in QD is equal to % change in price

1-∞ PED value

• relatively elastic

• % change in QD is greater than % change in price

∞ PED value

• perfectly elastic

• % change in QD will fall to zero with any % change in price

• highly theoretical

determinants of PED

SPLAT

substitutes

• good availability of substitutes results in higher PED (relatively elastic)

price of product as a proportion of income

• the lower the proportion of income the price of the product represents, the lower the PED will be

• consumers are less responsive to price changes on cheaper products

luxury

• luxury products are elastic

• necessities are inelastic

addictiveness

• if product is addictive, low PED value

time period

• in short term: consumers are less responsive to price INCREASES resulting in a low value of PED

• in long term: consumers may feel the price increase more and will then look for substitutes, resulting in a high value of PED

total revenue rule

in order to maximise revenue, producers must increase prices on products that are inelastic in demand, and decrease prices on products that are elastic in demand

diagram of revenue when tax on elastic vs. inelastic (govs)

diagram of good that is price elastic in demand

• shallow curve

• there is a greater than proportional increase in QD in response to a decrease in price

• a small decrease in price leads to a large increase in QD

• total revenue is higher once price is decreased

diagram of good that is price inelastic in demand

• steep curve

• there is a smaller than proportional decrease in QD in response to an increase in price

• a large increase in price leads to a smaller decrease in QD

• TR is higher once price is increased

implications of PED for firms and governments

• knowledge of PED is important to maximise revenue

• knowledge of PED is important to governments for taxes and subsidies

  • if they tax price inelastic in demand goods, they can raise tax revenue without harming firms excessively

  • if they subsidise price elastic in demand goods, there can be a greater than proportional increase in QD

income elasticity of demand (YED)

• how responsive the change in QD is to a change in income

• engel curves are used to represent this relationship

YED formula

interpreting YED values

• a positive YED value means it’s a normal good (luxury or necessity)

• a negative YED value means it’s an inferior good

YED<0 value

• inferior good

• e.g cheap cereal

0-1 YED value

• necessity

• normal good

• income inelastic, which means it’s relatively unresponsive to a change in income

• e.g loaf of bread

YED>1 value

• luxury

• normal good

• income elastic, which means it’s relatively responsive to a change in income

YED determinants

• influenced by any factors in an economy that will change wages of workers

• e.g during a recession wages usually fall, and demand for inferior goods increase swhilst demand for luxury goods falls

price elasticity of supply

how responsive the change in QS is to a change in price

PES formula

0 PES value

• perfectly inelastic

• QS is completely unresponsive to a change in P

• e.f fixed number of seats in a theatre

0-1 PES value

• relatively inelastic

• the % change in QS is less than proportional to the % change in P

1-∞ PES

• relatively elastic

• % change in QS is more than proportional to the % change in P

∞ PES value

• perfectly elastic

• the % change in QS will fall to zero with any % change in P

• very theoretical

determinants of PES

MATUR

mobility of FOP

• if producers can quickly switch their resources between products, then PES will be more elastic

• e.g if prices for hiking boots increase, shoe manufacturers can switch resources from trainers to boots

ability to store goods

• if products can be easily stored, then PES will be higher as producers can quickly increase supply (e.g canned goods)

• inability to store products results in lower PES

time period

• in short term: producers may find it harder to respond to an increase in prices as it takes time to produce the product e.g avocados

• in long term: they can change any of their factors of production so as to produce more

unused capacity

• if price increase for a product and there is a capacity to produce more in the factories that make those products, then supply is elastic

• if there is no spare capacity to increase production, supply will be inelastic

rate at which cost of production increase

• it costs more to produce each additional unit of output

• if the rate of the marginal cost increase is low, then the QS will be more elastic

• if marginal costs rise quickly, QS will be more inelastic