Ch 4 - Elasticity Of Demand 

  • Price elasticity of demand: measure of the responsiveness of quantity demanded to a price change. if a price is elastic, it is very responsive, if it is inelastic, it’s not responsive   * Key words:     * Ed = elasticity of demand     * Qd = quantity of demand     * P = price     * %△ = percentage change     * Ed = %△Qd / %△P

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  • Steps:

     1. % change in Qd : New quantity - old quantity * 100 Old quantity   2. % change in price : New price - Old price * 100Old price   3. %△Qd / %△P   4. Ignore negative sign

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  • If the answer is:   * Between 0 and 1: price inelastic demand   * 1: unitary price elastic demand   * Above 1: price elastic demand

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  • Inelastic demand curve:   * When a product’s PED is inelastic and the price falls, the firm will face loss in revenue

 

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  • Elastic demand curve:   * When the selling price of a product that has an elastic PED is decreased, the revenue increases (they sell more)

 

  • Perfectly elastic demand curve:

 

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  • The PED (price of elasticity of demand) will reduce as the price falls   * Demand becomes less elastic

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  • Determinants of PED:   * Availability of substitutes (too many choices)   * Time   * Luxury   * Proportion of income is spent on a good   * Income elasticity of demand: measures the extent to which the quantity demanded of a product is affected by an income   * IED = %△Qd / %△ in income

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  • For most normal accounts:   * Rise in consumer income = rise in demand   * Fall in consumer income = fall in demand   * Normal goods = positive YED   * Normal necessities = income inelastic   * Normal luxuries = income elastic

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  • Inferior goods: as income rises, demand falls (consumers look for more affordable substitutes)   * Has negative IED, less than zero
  • Normal goods YED > 0:   * Increased income = higher demand   * Positive elasticity
  • Luxury goods YED > 1:   * Increased income   * Bigger % increase in demand
  • Inferior goods YED < 0:   * Increase income leads to fall in demand   * Negative elasticity

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  • Unitary IED: perfectly proportional, Ey = 1
  • Zero income IED: consumer’s income doesn’t affect demand on product, Ey = 0

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  • An Engel curve shows the relationship between demand for a good (x-axis) and income level (y-axis)   * Positive slope: normal good   * Negative slope: inferior good   * PES price elasticity of supply: a measure of how much the quantity supplied of a product changes when there's a change in its price     * PES = %△ quantity supplied of the product / %△in price of the product

 

  • More time being considered = increased elasticity of a product
  • If total costs rise, supply will not be raised

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  • Cross elasticity of demand (XED): measure of how much the demand of a product changes when there's a change in the price of another product   * XED = %△in quantity demanded of X / %△ in price of product Y   * If value of XED = positive, goods are substitutes for each other   * If value of XED = negative, goods are complements of each other   * If value of XED = 0, goods are unrelated

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