CH5: Elasticity Flashcards
(22 cards)
How does elasticity affect total revenue?
Shows how price changes affect revenue. Total Revenue (TR) = Price (P) × Quantity (Q). / If demand is inelastic, a price increase increases total revenue. / If demand is elastic, a price decrease increases total revenue.
What is elasticity in economics?
Elasticity is a measure of how responsive quantity demanded or supplied is to a change in price or other factors (like income or price of related goods).
Types:
Price elasticity of demand: % change in quantity demanded ÷ % change in price
Elastic = responsive
Inelastic = unresponsive
What is price elasticity of demand and how is it calculated?
It measures the percentage change in quantity demanded when the price changes by 1%, ceteris paribus. / ep = (% change in quantity demanded) / (% change in price).
What is the formula for elasticity and what does it represent?
Elasticity = (% Change in Quantity Demanded) ÷ (% Change in Price)
Represents:
How responsive consumers are to price changes.
Elastic (Ed > 1): very responsive
Inelastic (Ed < 1): not very responsive
Elasticity = % change in dependent variable / % change in independent variable.
What paradox occurs when farmers increase production?
When farmers increase production (e.g. after a good harvest), the total supply increases, causing market prices to fall—but because demand for food is inelastic, the drop in price outweighs the gain in quantity sold, so total revenue falls.
Why it’s a paradox:
It seems logical that producing more should earn more income. But in reality, more output leads to lower earnings, which is the opposite of what one would expect—hence, a paradox.
concept
Explanation
elastic demand
When a small change in price leads to a large change in quantity demanded.
Key Traits:
Elasticity > 1
Many substitutes available
Luxury or non-essential goods
Often a large portion of the consumer’s budget
Give an example of price elasticity calculation: A store increases the price of a product from R100 to R120. As a result, quantity demanded falls from 500 units to 400 units.
Step 1: Calculate % change in quantity demanded
= [(400 − 500) ÷ 500] × 100
= (−100 ÷ 500) × 100 = −20%
Step 2: Calculate % change in price
= [(120 − 100) ÷ 100] × 100
= (20 ÷ 100) × 100 = +20%
Step 3: Apply formula
Elasticity = (% Change in Quantity Demanded) ÷ (% Change in Price)
= (−20%) ÷ (+20%) = −1
Interpretation:
Elasticity = 1 (unit elastic): Revenue will remain roughly the same despite the price change.
perfectly elastic demand
Demand where any price increase causes quantity demanded to drop to zero.
Key Trait:
Horizontal demand curve
Consumers will only buy at one exact price
Often theoretical (e.g. in perfectly competitive markets)
what does ep < 1 imply?
A price elasticity of demand less than 1 means demand is inelastic.
Implication:
Quantity demanded changes less than price
Consumers are not very responsive to price changes
Raising price increases total revenue
what does ep = 1 imply?
A price elasticity of demand equal to 1 means percentage change in price equals percentage change in quantity demanded.
Implication:
Total revenue stays the same when price changes
Demand is proportionally responsive
what does ep > 1 imply?
A price elasticity of demand greater than 1 means quantity demanded changes more than the price.
Implication:
Consumers are highly responsive to price changes
Lowering price increases total revenue
Often applies to luxuries or goods with many substitutes
what is arc elasticity?
A method to calculate price elasticity of demand between two points on a curve, giving a more accurate average when price or quantity changes significantly.
Formula:
Ep = [(Q2 − Q1) ÷ (Q2 + Q1)/2] ÷ [(P2 − P1) ÷ (P2 + P1)/2]
Purpose:
Avoids bias from choosing starting or ending point
Useful for real-world scenarios with noticeable price/quantity shift
Helps measure average responsiveness over a range rather than at a single point
what is inelastic demand?
When quantity demanded changes less than the price does.
Key Traits:
|Ep| < 1
Consumers are not very responsive
Often applies to necessities (e.g. petrol, bread)
Price ↑ → Revenue ↑
what is perfectly inelastic demand?
Quantity demanded does not change at all when price changes.
Key Traits:
Ep = 0
Vertical demand curve
Applies to essential goods with no substitutes (e.g. life-saving medication)
Price ↑ or ↓ → Quantity stays the same
what is point elasticity?
Measures price elasticity of demand or supply at a specific point on the curve (rather than over a range).
Formula (Demand):
Ep = (dQ/dP) × (P ÷ Q)
(Uses calculus or estimated slope)
Purpose:
Best for small, precise price changes
Often used when changes are infinitesimally small
More theoretical than arc elasticity
what is the formula for arc elasticity?
ep = ((Q2 - Q1) / (Q1 + Q2)) / ((P2 - P1) / (P1 + P2)).
what is the impact of a steeper demand curve on elasticity?
A steeper demand curve means less responsive demand and greater price changes.
what is the shape of a perfectly inelastic demand curve?
Vertical line – quantity remains constant despite price changes.
what is the shape of a unitarily elastic demand curve?
A demand curve where every % change in price leads to an equal % change in quantity demanded (Ep = 1).
Shape:
A rectangular hyperbola
Curves downward, but total revenue remains constant at every point
Not a straight line, unlike linear demand curves
Key Trait:
Price × Quantity = constant at all points on the curve
what is unitary elasticity?
ep = 1 – Quantity and price change in equal proportions.
