Flashcards in Chapter 3: Elasticity Deck (79):
When is a product price inelastic?
When it has few substitutes and the quantity demanded of the product is very insensitive to changes in price.
When is a product price inelastic?
When there are other firms that can offer a much cheaper price for the same product and the quantity demanded of that product is very sensitive to changes in price.
What would be the result of an increase in the price of a price elastic product?
It would lead to a more than proportionate fall in the quantity demanded.
What does price elasticity of demand measure?
The responsiveness of quantity demanded to a change in price.
What is the formula for price elasticity of demand?
% change in quantity demanded/ % change in price
Why are results negative for PED?
Demand curves slope downwards therefore we expect to see that as price rises, the quantity demanded falls.
What are the ranges for PED?
0 = perfectly price inelastic, 1 = price elastic and infinity is perfectly price elastic.
What is the shape of a perfectly price inelastic demand curve and why is this the case?
A vertical line as no matter how much price rises or falls, the same quantity is always sold. The quantity demanded is completely insensitive to changes in price.
What is the shape of a perfectly price elastic demand curve and why is this the case?
A horizontal line as this shows the firm can sell as much as it wishes at a given price. However, a rise in price leads to demand falling to zero.
What is the result of an increase in price of a product that is price inelastic?
There will be a less than proportionate fall in the quantity demanded.
What are the features of a unitary product?
The demand curve is a rectangular hyperbola, the total revenue stays unchanged at every point on the demand curve, a change in price always leads to a proportionate change in the quantity demanded.
What is the definition of total revenue?
A firm's total earnings from a given quantity of sales.
How will a price increase impact revenue?
Revenue too will increase providing that the product is price inelastic.
What is total revenue equal to?
Price x quantity
How is revenue illustrated on the demand curve?
It is shown by the area underneath the demand curve.
When does 'maximisation of total revenue occur'?
When the PED is -1.
What varies along any straight line demand curve and what does this mean?
Elasticity and this means that if a firm continued to increase its price, it will not experience ever-increasing rises in total revenue.
What are the factors affecting PED called?
Determinants of PED.
How can the number and closeness of substitutes impact PED?
If there are few substitutes for a product then these products are price inelastic so firms can afford to increase prices and still expect an increase in revenue.
Why do some firms spend a huge amount of money on marketing and branding?
They want to make consumers believe that their product is unique and original, this can create the perception that there are no real substitutes. Successful branding can alter the PED for a product and make it less elastic.
How does the proportion of income for which a good accounts affect PED?
Firms are able to increase the prices of items that already had low prices as they account for such a small proportion of a person's income.
How does the influence of habit impact PED?
Addictive goods tend to be price inelastic, these products are fairly insensitive to changes in price meaning that the government can afford to tax them without firms losing a large amount of revenue.
What does income elasticity of demand measure?
The responsiveness of demand to a change in income.
What can firms use PED to predict?
The effect of a change in price on total revenue and expenditure on a product, the price volatility (variation) in a market following changes in supply, the effect of a change in an indirect tax on price and quantity demanded, businesses can use this information as part of a policy on price discrimination, usually a business will charge a higher price to consumers whose demand for the product is price inelastic.
What is the formula for income elasticity of demand?
% change in quantity demanded / % change in income
Why is a positive sign expected for income elasticities?
We expect that with more income, people will tend to buy more of a commodity.
What is a normal good?
A good for which as incomes rise, demand rises too.
When are goods income elastic?
When demand for some goods is very sensitive to changes in income.
What will make a perfectly income inelastic product?
If the demand for a product is completely insensitive to changes in income. The income elasticity of demand would be equal to zero throughout it's range.
What classifies a product as income inelastic?
When there is a less than proportional increase in the quantity demanded of a product as incomes rise.
When does a negative sign occur for income elasticity of demand?
When the product is an inferior good.
What is an inferior good?
A good in which as incomes rise, demand falls.
Can the income elasticity of demand for a product change overtime?
What will impact consumer perceptions of the value and desirability of a good or service?
Their own experiences of consuming a product and the appearance of new products onto the market.
What does cross elasticity of demand measure?
The responsiveness of demand for one good given a change in the price of another.
What is the formula for cross elasticity of demand?
% change in quantity demanded of X/ % change in the price of Y
What are substitutes?
Goods in competitive demand.
What are complements?
Goods in joint demand.
What is the relationship between two weak substitutes?
A substantial rise in one of the products leads to a less than proportionate rise in the demand for the other. The cross elasticity of demand will be positive but less than one therefore weak substitutes are cross inelastic.
What is the relationship between two weak complements?
A substantial rise in the price of one product will lead to a less than proportionate fall in demand for another product. The cross elasticity will be negative and less than 1 therefore weak complements are cross inelastic.
What is the relationship between two close substitutes?
An increase in the price of one will lead to a more than proportionate rise in demand for the other product. The cross elasticity will be positive and more than one therefore close substitutes are cross elastic.
What is the relationship between two close complements?
A increase in the price of one product will lead to a more than proportionate fall in demand for the other product. The cross price elasticity will be negative and more than one therefore two weak complements are cross elastic.
What is the cross elasticity of products that are neither substitutes or complements?
It is most likely to be zero.
What do businesses use cross elasticity of demand for?
To help them maximise their sales and profit as they can predict what will happen to demand of their own product based on changes in prices of complements and substitutes.
What does the graph look like for products that have zero cross elasticity?
It is a vertical line.
What happens when consumers become habitual purchasers of a product due to strong branding?
The cross elasticity of demand against rival products will decrease. This reduces the size of the substitution effect and makes demand less sensitive to changes in price. As a result, firms may be able to charge a higher price, increase their total revenue and turn consumer surplus into higher profit.
How does an increase in price affect supply?
It increases too.
In what period are suppliers unable to respond to?
The momentary period.
What do suppliers do when they only have a certain amount to supply and they have more consumers than possible to satisfy?
They give out their products to those that are willing to pay the highest prices.
What does price elasticity of supply measure?
The responsiveness of quantity supplied to a change in price.
How is price elasticity of supply calculated?
% change in quantity supplied / % change in price
Is it possible for suppliers to respond in the short run to an increase in demand? If so, how?
Yes as in the short run suppliers can respond to increases in demand for their product by hiring more labour in order to increase production.
What is the price elasticity of supply in the momentary period?
Zero which is perfectly price inelastic.
What time period does 'short run' refer to?
The period of time where at least one factor of production is fixed.
In which time period is supply more elastic? Short run or momentary? Why?
Short run as the employment of more labour brings about an increase in production.
What period of time does the 'long run' refer to?
That period of time where all factors of production are variable.
What is the most important factor in determining the price elasticity of supply?
What makes long run supply more elastic?
Adding to capital stock.
How does the flexibility of resources affect the price elasticity of supply?
It may be possible to switch labour and raw materials away from one product toward another however this assumes that these factors of production are close substitutes and that they can be switched easily. If resources are flexible it will mean that supply will be more price elastic.
How do the levels of stocks affect the price elasticity of supply?
If stocks existed, that would allow the supplier to supply more in the momentary period.
How does availability of resources affect price elasticity of supply?
When demand for a product rises, suppliers need to obtain more resources to increase production however more resources may not be obtainable thus physical constraints reduce the responsiveness of supply to changes in price.
Why is it desirable for a firm to be highly responsive to changes in price and other market conditions?
A high PES makes a firm more competitive than its rivals and it allows the firm to generate more revenue and profits.
What are some examples of actions that a firm could take to improve their speed of response to changes in market conditions?
Creating spare capacity, using the latest technology (to perhaps prolong the shelf life of products), keeping sufficient stocks or developing better storage systems, developing better distribution systems, providing training for workers or hiring flexible workers who can do a range of jobs and locating production near to the market.
What will happen if the price of a price elastic product is increased?
The rise in price will lead to a more than proportionate fall in the quantity demanded.
What does the graph for revenue against quantity look like?
It is a quadratic curve that has a maximum which is when the PED is -1.
On the demand curve, which parts are elastic and which parts are inelastic?
It is price elastic from when the quantity is zero up until the PED is -1 and then from there the price is inelastic.
Why is it important that firms use PED to predict price volatility in a market following changes in supply?
This is important for commodity producers who suffer big price and revenue shifts from one time period to another.
What is another thing that PED is used to predict in terms of taxes?
Whether the firm will be able to pass on some or all of the tax onto the consumer.
What is price discrimination?
When a supplier decides to charge different prices for the same price to different segments of the market.
Give an example of price discrimination
Peak and off peak rail travel prices charged by many of our domestic and international airlines.
What classifies a product as income elastic?
When there is a more than proportionate increase in quantity demanded when incomes rise.
Give an example of a product that has changing income elasticities.
A flat-screen TV: with no income you are unable to purchase any however as your income increases you are able to purchase more flat-screen TVs (normal good) however the quantity demanded falls after a while even though your income is still increasing as there are only so many TVs that you really need (inferior good).
What does the graph look like for weak substitutes?
It is upwards sloping with a steep gradient.
What does the graph look like for close substitutes?
It is upwards sloping however the gradient is shallow.
Give some examples of questions an airline might have to ask after a change in price of one of it's competitors.
Will many consumers switch? Will they have the capacity to meet an expected rise in demand? Will the other firm match a price rise? Will it follow a price fall?
How can firms use information on cross-elasticity of demand for complements?
If products are really strong complements, then firms can estimate what would happen if they were to make a deal for one product and if they would see a large increase in the demand for the other product which would compensate for the lower cost of the first product.
Why do businesses spend huge amounts of money each year on persuasive advertising and marketing?
The aims include attempting to shift the demand curve for a product outwards and build consumer loyalty to the brand.
What does the supply curve look like in the momentary period?
It is a vertical line.