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What is elasticity?
A measure of how sensisitive one variable is to proportional changes to another variable
You can replace the word elasticity to sensitity, and it will mean the same thing in economics.
What is PED and give the formula.
PED is the price elasticity of demand. Basically how sensitive the demand is to changes in price in the same good, ceteris paribus.
PED is given as %Change in Quantity Demanded / % Change in Price.
Note that it refers to proportional changes.
Why is the PED generally negative and
what does it mean when the PED is:
|PED| = ∞
|PED| > 1
|PED| < 1
|PED| = 0
PED is generally negative because when prices increases quantity demanded always decreases (law of demand)
|PED| = ∞ → Demand is perfectly price elastic. Any change in P, infinite change in Qd
|PED| > 1 → Demand is price elastic. Small change in P, big change in Qd
|PED| < 1 → Demand is price inelastic. Big change in P, small change in Qd
|PED| = 0 → Demand is perfectly price inelastic. Any change in P, no change in Qd
Which part of a linear demand curve is the PED elastic, inelastic, and unitary?
PED decreases as you move down the demand curve
What is total revenue?
How do you read the total revenue (or total expenditure from a consumer’s perspective) from a demand curve?
Total revenue/expenditure is P x Q
You can read it from the area of a rectangle that is under the demand curve.
How do you read elasticity from a revenue/expenditure vs quantity curve (assuming linear demand curve).
When the total revenue is rising as the Qd increases, the good is price elastic.
When the total revenue it falling as Qd increases, the good is price inelastic
For something which demand is price elastic, how can the firm increase total revenue?
They can lower prices.
To get more revenue firms can either increase Qd or P. When they lower prices for sth that is elastic, the Qd increases in a greater proportion.
For something which demand is price inelastic, how can the firm increase total revenue?
They can increase prices.
To get more revenue firms can either increase Qd or P. Since for sth which demand is inelastic changes in P will not affect the Qd so much, increase P can increase total revenue.
What will a change in price for sth which demand is unitary price elastic do to the total revenue?
The total revenue will not change
(Note: this refers to tiny tiny changes in price. If you tested the above with real numbers, the total revenue will always drop, as technically when sth is unit elastic the total revenue is at its maximum)
The elasticity that A-levels refers to is the point elasticity, not the arc elasticity (which is what you calculate when you take the difference in P or Qd and divide it by the original to calculate %changes in P or Qd)
Give the determinants of PED.
A good’s PED is affected by:
S.P.L.A.T
The availability of Substitutes (whether ppl can switch easily or not)
The closeness of Substitutes (whether ppl can switch easily or not)
Proportion of income spent on the good. (ppl will be more sensitive to “expensive” things)
The degree of its Luxury or necessity. (If you really need sth, you will buy it with less regard to the price.)
Addictive products are generally inelastic
Time period in consideration (ppl will adjust buying patterns with a longer period of time, short term they just buy)
Why should one avoid arguing that sth is price elastic due to its low degree of necessity?
Most things on the market are non-essential.
When you say that sth is price elastic because it has a low degree of necessity, you are saying most things in the market are elastic, which makes the statement more meaningless and too general.
You can argue the converse (that sth is inelastic because of high degree of necessity) because that applies to less goods.
Why should one avoid arguing that because sth has low number of substitutes, it is inelastic?
Something can have low number of substitutes that are very close substitutes, which will make it elastic again.
One should also becareful with the converse arguement, as having a large amount of substitutes that aren’t very close might not make sth elastic.
What are the applications of PED?
Firms can strategise and decide whether to raise prices or not.
The government can predict how consumers will react to price changes, and hence plan whether to tax/subsidise certain products.
They can also consider how a change in tax/subsidy will affect tax revenue.
What is YED and give the formula.
YED measures the degree that quantity demand responds to changes to income, ceteris paribus
Y refers to income in economics.
YED = %Change in Qd / %Change in P
What does it mean when the YED is:
Positive
Negative
|YED| > 1
|YED| < 1
|YED| = 0
Positive YED means the when income increases, the demand for the good increases, showing that they are normal goods.
Negative YED means the when income increases, the demand for the good decreases, showing that they are inferior goods.
|YED| > 1 → Demand is income elastic.
If YED was positive the goods could be luxury goods (You might buy jewlery if you got richer). If YED is negative it just means that the good is very inferior.
|YED| < 1 → Demand is income inelastic.
If YED was positive the goods could be necessity goods (You wont buy more toilet paper if got richer). If YED is negative it just means that the good is inferior.
|YED| = 0 → there is no relationship between income and demand
What are the appplications of YED?
It is useful for companies to predict how much should they produce in the future (production capacity), based on expectations of people’s future change in income.
Eg, lets say companies think there is a recession coming. If the YED of thier products > 1, it means that they will be affected a lot when people’s income fall, hence they might prepare to produce less things.
It can also inform the firm whether to focus their marketing strategy on inferior or normal goods.
What are the determinants of YED?
Degree of luxury of a good. (The more luxurious the product, the more sensitive it is to income changes
Overal level income level of the consumers. (The richer people are, the less sensitive they are to the price of things, hence demand changes less proportionally when they experience a change in income)
What is XED and give its formula.
XED is the cross elasticity of demand. It measures the degree which the quantity demand of one product responds to a change in price of another product, ceteris paribus.
XED = %Change in Qd of A / %Change in P of B
What does it mean when XED is:
positive
negative
|XED| > 1
|XED| < 1
|XED| = 0
When XED is positive, Products A and B are substitutes (When P of A increases, Qd of B increases)
When XED is negative, Products A and B are complements (When P of A increases, Qd of B decreases)
|XED| > 1 → Products are cross-elastic, if positive, it means A and B are strong substitutes. If negative, A and B are strong complements
|XED| < 1 → Products are cross-inelastic, if positive, it means A and B are weak substitutes. If negative, A and B are weak complements
|XED| = 0 → There is no relationship between A and B
What are the applications of XED?
Firms can use the XED to identify their competitors and respond correctly if they decide to change their price. If they sell 2 or more products they can identify which products are complements and hence increase revenue by prioritising the correct ones.
What are the determinants of XED?
Positive → The closeness of the substitutes
Negative → The strength of the complements
What are the limitations of PED, YED and XED?
To calculate elasticities, data is required. If the data is unreliable, it will make elasticity calculations unreliable too.
The assumption ceteris paribus is unlikely to hold in reality. These elasticities can only investigate the response to the change of specific things, but in the real world there many factors at play that can alter the analysis of the situation.
Ommision of total cost in PED. When using PED, you can only make judgements as to whether total revenue will increase or not. It tells you nothing about total cost, and hence nothing about profit.
PED and XED also do not tell you anything about the production capacities of the firms. While sth can be price elastic, firms may not be able to produce enough to meet the demand.
What is PES and give its formula.
PES is the price elasticity of supply. It measures the degree of responsiveness of quantity supplied to changes in price, ceteris paribus.
PES = %Change Qs / %Change P
Why is PES always positive and what does it mean when it
PES = ∞
PES > 1
PES < 1
PES = 0
PES is always positive because of the law of supply.
PES = ∞ → Supply is perfectly elastic to price.
PES > 1 → Supply is elastic to price. Change in price, supply responds very well. Very easy to supply.
PES < 1 → Supply is inelastic to price. Change in price, supply doesnt respond by alot. Difficult to supply sth.
PES = 0 → Supply is perfectly inelastic to price. No matter the price, the Qd stays the same. This can happen when the time period is too short for sth to be produced.
What are the factors that will affect PES?
PES is all about ease and/or speed of production.
1) Length of production period. The longer it takes to produce something, the more difficult for supply to respond to price, so the PES will be inelastic.
2) Time period in consideration. Note the difference compared production time. Over a longer period of time, companies can build up the supply required. PES is elastic with a longer time period in consideration.
3) Availability of excess capacity. The closer the company is to max capacity, the more difficult it is for the company to supply more in response to a price change. More excess capacity, PES is elastic.
4) Stockability. Whether can companies stockpile the good of not, similar to availability of excess supply, but refers to finished goods.
5) Mobility/availability of factors of production. How easy it is to mobilise the factors of production that is required for production. If it is mobilise the factors of production, PES is elastic.
What are the applications of PES?
PES can tell you the extent which an increase in demand will cause an increase in price. Consider 2 graphs, one with the SS very steep (inelastic) and another with the SS very shallow (elastic). When the DD curve shifts in the two graphs, look at how the equilibrium price changes.
PES can also help you identify manufactured goods and agricultural goods. (Ease of production!)
Note 
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