Extensions of Demand and Supply Analysis

Flashcards on Extensions of Demand and Supply Analysis

Elasticity

Measures the responsiveness or sensitivity of quantity demanded to changes in price; by how much quantity demand change when there is a change in price

Price Elasticity of Demand

A tool to measure the responsiveness of quantity demanded to changes in price and to help suppliers in decision-making.

Relatively Elastic

Modest changes in price cause very large changes in quantity demanded.

Relatively Inelastic

Substantial changes in price cause small changes in quantity demanded.

Price Elasticity of Demand

Measures the responsiveness of quantity demanded to a change in the price of the good or service, calculated by looking at the percentage change in quantity demanded divided by the percentage change in price.

Price Elasticity of Demand

When price goes up, quantity demanded goes down, implying a negative relationship; absolute values are used, and the negative value is ignored.

Elastic Demand

If the price elasticity of demand is greater than 1.

Inelastic Demand

If the price elasticity of demand is less than 1.

PED = 0

There is 0 change in quantity demanded, no matter what the change in price is.

Perfectly Inelastic Situation (PED = 0)

Demand curve looks like a straight line; irrespective of the price, quantity demanded is not going to change.

0 < PED < 1

Price elasticity of demand is greater than 0 but less than 1; there is a small change in quantity demanded, steep demand curve.

0 < PED < 1

Small Change, Relatively Inelastic

PED = 1

Quantity demanded is changing in the same percentage as the change in price.

PED = 1

Unit Elasticity

1 < PED < ∞

PED is greater than 1, but less than infinity; demand curve has a flat slope, big change between Q1 and Q2.

1 < PED < ∞

Big Change, Relatively Elastic

PED = ∞

If the PED is equal to infinity, the demand curve is horizontal; even the smallest change/increase in the price, there will be an infinite change in the quantity demanded.

PED = ∞

Perfectly Elastic

Flatter Demand Curve

Demand that is elastic, refers to a big change.

Steeper Demand Curve

Demand that is inelastic, refers to a small change.

Total Revenue

Price x Quantity

Elasticity

Studied to determine whether suppliers should increase the price of a good, which depends on whether the good is demand elastic or demand inelastic.

Inelastic

Percentage change in quantity is less than the percentage change in price, changes in price 'directly' changes in total revenue

Elastic

Percentage change in quantity is greater than the percentage change in price, changes in quantity directly changes in total revenue

Unit Elastic

Percentage change in quantity is equal to percentage change in price, total revenue remains the same

Substitutability

The larger the number of substitute goods available, the greater the Ed.

Proportion of Income

The higher the price of a good relative to consumers’ incomes, the greater Ed.

Luxuries Versus Necessities

The more a good is considered to be a ‘luxury’ rather than a ‘necessity’, the greater is the Ed.

Time

Product demand is more elastic the longer the time period under consideration.

Cross-Elasticity of Demand

Measures how sensitive consumer purchases of one product are to a change in the price of some other product.

Substitute Goods

Goods that can be used instead of one another.

Substitute Goods

The XED for substitutes is ALWAYS POSITIVE

Complementary Goods

Goods that go together.

Complementary Goods

The XED for complementary goods is ALWAYS NEGATIVE

Income Elasticity of Demand

A percentage change in INCOME, not price; by how much does demand change when there is a change in income?

Normal Goods

For normal goods, when your income increases, your quantity demanded will increase as well, positive relationship, income elasticity of demand is greater than 0 (positive).

Inferior Good

A good that you will buy less of when your income increases, quantity demanded will decrease; income elasticity of demand for inferior goods will always be negative, income elasticity of demand is less than 0 (negative).