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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