L5 - Elasticity Flashcards
What are Determinants of Price Elasticity of Demand?
- Availability of close substitutes
- Necessities versus luxuries
- Definition of market (market demand versus firm demand)
- Time Horizon
How is availability of close substitutes a determinant of price elasticity of demand?
Goods with close substitutes tend to have more elastic demands
- if there is a small price increase, buyers will switch to the alternatives
How is Necessities versus luxuries a determinant of price elasticity of demand?
Goods that are essential tend to have less elastic demand
- if price rises for an essential good, buyers must continue to buy it
How is the Definition of market (market demand versus firm demand) a determinant of price elasticity of demand?
Narrowly defined markets have more elastic demand than broadly defined
markets
- it is easier to find substitutes for a narrowly defined market
How is the Time Horizon a determinant of price elasticity of demand?
Demand is more elastic when the associated time period is longer
- it is easier to substitute away from a product in the long run than in the short
run
- durable products will tend to be substantially more elastic than any of the short-run demand curves
- not always the case as automobiles in the long run may be as low as -0.2 while in the short run can be -1.2-01.4
How do you calculate the price elasticity of demand?
- PED = η = (% change in quantity demanded)/(% change in price)
- we interpret elasticities on their absolute value ( no negatives)
- Giffen goods break the law of demand e.g. staple foods
What do the values of Price Elasticity of demand tell us?
- Inelastic (0 > PED < 1): Quantity demanded changes proportionally less
than price - Unit Elasticity –> PED=1 –> Quantity changes proportionally to price
- Elastic (1 > PED > ∞): Quantity demanded changes proportionally more
than price - All that above 0 are ordinary goods
- All that is below 0 are giffen goods
What is a Giffen Good?
a good that is in greater demand as its prices increases
- it may mean that consumers have less money to buy more expensive foods so they will actually be forced to buy more of the staple food like rice
What are the two special cases of Price Elasticity of Demand?
- Perfectly inelastic: any increase in price has no effect on the quantity demanded –> vertical line on the graph –> necessities
- Perfectly elastic: any increase in price reduces the quantity demanded to zero —> horizontal line on a graph –> luxury items
What is the midpoint rule when calculate elasticises?
- to work out the percentage changes instead of doing for example (Change in P)/(original P) you would do the (change in P)/(the midpoint of the change of P)
How can Price Elasticity be related to total expenditure?
- Total expenditure is how much is spent by buyers on a good: price x amount bought. Whether a price increase raises or lowers total expenditure depends upon PED.
- A price increase with inelastic demand raises total expenditure
- A price increase with elastic demand lowers total expenditure
How is Income Elasticity calculate?
YED/IED= (%change in quantity demanded)/(% change in income)
- The sign of IED tells us whether income increases quantity demanded or not
How can Normal Goods be interpreted for income elasticity?
quantity demanded increases with a rise in income
- For necessities: income elasticity of demand is between 0 and 1,
i. e. demand increases less rapidly than an increase in income - For luxuries: Income elasticity of demand is greater than 1,
i. e. demand increases more rapidly than an increase in income
How can Inferior goods be interpreted for income elasticity?
quantity demanded decreases with a rise in income; example: buses
- less than 0
What is the Cross- price Elasticity of Demand?
- This measures how much the quantity demanded of ONE good changes if the
price of ANOTHER good changes. - CED= (% change in quantity demanded of good A)/(% change in price of good B)
