Unit 3: Elasticity

price elasticity of demand (PED)

measure of the responsiveness of a good demanded to price changes

Ranges for PED

• PED = ∞ - perfectly elastic; Qd is infinitively responsive to ΔP

• PED >1 - price elastic; Qd is relatively responsive to ΔP

• PED = 1; unitary PED; %ΔQd = %ΔP

• 1 > PED > 0 - price inelastic; Qd is unresponsive to P

• PED = 0 - perfectly inelastic; %ΔQd is 0

Determinants of PED

• Substitues

  • more subs = incr. PED

  • closer subs = incr. PED

  • specific goods = incr. PED

• Necessities vs/ Luxuries

  • necessities = decr. PED

  • luxuries = incr. PED

• Length of Time

  • the longer a consumer makes a purchasing decision = incr. PED

• Proportion of Income Spent on a Good

  • higher proportion = incr. PED

Total Revenue

amount of money received by firms when they sell a good/service

TR = P x Q

Income Elasticity of Demand (YED)

measure of the responsiveness of demand to changes in income

YED w/ Normal Vs. Inferior Goods

• Normal Good - when demand & income change in the same direction; positive & YED > 0

• Inferior Good - when demand & income change in different directions; negative & YED < 0

YED w/ Necessities vs. Luxuries/Services

• Necessities - if 0 > YED > 1; % incr. Y is greater than % incr. Qd

• Luxuries/Services - if YED > 1; % incr. Y is less than % incr. Qd

Engel Curve

• diagram of income vs. quantity

• YED > 0 upward slope

• YED < 0 downward slope

YED w/ Gov’t Intervention

• Taxes

  • lower taxes = YES incr.

• Subsidies

  • more subsidies to consumers = income incr.

Price Elasticity of Supply (PES)

measure of responsiveness of the quantity of a good supplied to changes in its price

Determinants of PES

• Length of Time

  • if length of time increases = PES incr.

• Mobility Factors of Production

  • easier rescources can be shifted = PES incr.

• Spare (Unused) Capacity of Firms

  • the greater the unused capacity = PES incr.

• Ability to Store Stocks

  • firms w/ the ability to store Qs = PES incr.

• Rate @ Which Costs Incr.

  • if production costs decrease = PES incr.