Economics - Elasticity

Define Price Elasticity of Demand. (PED)

The responsiveness of the quantity demanded to a change in price.

How is PED calculated?

% Change in Q.D./%Change in Price.

When is demand elastic?

When a change in price causes a bigger percentage change in demand.PED=>1

What does a graph with a PED = Infinity look like?

A horizontal demand line.

What does a PED = Infinity mean?

The good in perfectly elastic.

Characteristics of elastic demand.

A luxury good - a large portion of disposable income.

Has many substitutes.

Frequently bought - more likely to compare prices and switch if necessary

Big % of income spent

When is demand inelastic?

Demand is inelastic when a change in price is larger than the percentage change in demand.PED

What does a perfectly inelastic graph look like?

A vertical line, with a PED = 0.

Characteristics of a good with inelastic demand

Few substitutes - have few close alternatives.

Addictive - if addicted you will pay a higher price and will continually purchase a product.

Necessities.

A small percentage of income.

Why is demand usually more inelastic in the short term?

Because it takes consumers some time to find and switch to an alternative.

If demand is inelastic what will increasing the price usually do to revenue ?

Lead to an increase in revenue.

How is total revenue calculated?

Price per unit x units sold.

What will raising the price of an elastic good usually do to revenue?

Cause it to decrease.

How is advertising used to help with elasticity?

An inelastic good means the price can be raised with only a small fall in demand. Therefore, brands use advertising to increase brand loyalty and thus cause their good to become more inelastic.

Define income elasticity of demand. (YED)

The responsiveness of demand to a change in income.

How is YED calculated?

% Change in Q.D/%Chang in income.

What is an inferior good?

An inferior good is a product where demand actually falls as incomes increase e.g. supermarket own brand bread.

What is a normal good?

A good where demand increases when incomes do.

Luxury good?

This occurs when an increase in income leads to a bigger percentage increase in demand. YED>1.

What does income inelastic mean?

The percentage change in demand is less than the increase in income YED

If YED is negative then...

Inferior good

If YED is positive then?

Normal good

During a recession demand for inferior goods will increase, what will supermarkets do?

Supply more inferior goods and cut down on luxury goods.

What is the definition of Cross Price Elasticity of Demand? (XPED)

The responsiveness of demand for Good A to a price change of Good B.

What is the XEd equation?

%Change in Q.D. of Good A/%Change in Price of Good B.

What is a substitute good?

A good that can be used as a substitute for another.

Explain complement goods.

Two good that are used together e.g. DVDs and DVD players.

If XED is negative what does this mean?

Complements

If XED is positive what does this mean?

Subs+I+u+es

Unrelated goods?

Two goods where price increases of either would have no effect in demand on the other.

What is Price Elasticity of Supply? (PES)

The responsiveness of supply to a change in price.

How is PES calculated?

%Change in Supply/%Change in price.

What does inelastic supply mean?

When the change in price is larger than the percentage change in supply. PES

What does a perfectly inelastic supply graph look like and mean?

Vertical, means a change in price has no effect on supply.

Why might supply be inelastic?

A firm may be operating close to or at full capacity.

Low levels of stocks or components - there are few surplus goods.

In the short term capital is fixed - firms don't have time to increase capacity.

Difficult to employ factors of production - e.g. it may be difficult to find relevant skilled workers.

Agricultural products are inelastic in the short run - because crops take at least 6 months to grow.

When is supply elastic?

When the percentage change in price is smaller than the change in supply.

What does a perfectly elastic supply graph mean and look like?

Horizontal and that at a given price supply is unlimited.

Give three reasons why supply may be elastic?

There is spare capacity.

Stocks may be available.

It is easy to employ more factors of production.

Explain the difference between short run and long run.

In the short run, supply is likely to be more inelastic as the firm does not have the ability to increase the size of the factory.

In the long run. supply can be more elastic as the firm is able to invest in more capacity, thus increasing supply.