3. The Elasticity Concepts

Question 1

Define PED.

Answer 1

The price elasticity of demand measures the degree of responsiveness of quantity demanded of a good to a change in its price, centeris paribus.

Question 2

What are the determinants of PED?

Answer 2

1. Number and closeness of substitutes
2. Proportion of the consumer’s income spent on the good.
3. Adjustment Time Period

Question 3

What is the relationship between TR and PED? (Pricing strategies for producers)

Answer 3

1. PED >1
   A change in price leads to MTP change in quantity demanded.
   Decrease in Px -> increase in TR
   Increase in Px -> decrease in TR
2. PED < 1
   A change in price leads to LTP change in quantity demanded.
   Decrease in Px -> decrease in TR
   Increase in Px-> increase in TR

Note: PED can change over time or vary depending on different times in the year.
Eg. When a new model of mobile phone is released, demand tends to be more price elastic due to few close substitutes, but over time, rival firms would develop similar products, amkeing demand become more price elastic.
Eg. In the travel and hotel industry, during peak seasons, not only does demand increases, but demand is also relatively more price in elastic than off-peak periods.

Question 4

Define YED.

Answer 4

The income elasticity of demand measures the degree of responsiveness of demand for a good to a change in consumer’s income, centeris paribus.

Question 5

What are the determinants of YED?

Answer 5

Degree of necessity of the good
1. Income Level
2. Cultural considerations

Question 6

Define XED.

Answer 6

The cross elasticity of demand measures the degree of responsiveness of demand for one good to a change in the price of another good, centeris paribus.

Question 7

What are the determinants of XED?

Answer 7

1. Degree of closeness of the substitutes or complements

Question 8

Define PES.

Answer 8

The price elasticity of supply measures the degree of responsiveness of quantity supplied of a good to a change in its price, ceteris paribus.

Question 9

What are the determinants of PES?

Answer 9

1. Type of industry
   Length and complexity of the production process
2. Availability of spare capacity
   If firms have sufficient spare capacity, they should be able to increase output quite quickly without a substantial rise in costs. Therefore, supply will be relative more price elastic
3. Level of Stocks/ Ease of accumulating stocks
   If firms can readily get extra of raw material and component parts, they will be able to respond quickly to a rise in price. Price elastic supply
   If firms can easily store finished goods at low cost, the supply of the good is likely to be relatively price elastic.
4. Factor mobility
   Geographical/ occupational
5. Adjustment time period