Chapter 6 Flashcards by Allison Hortin

Elasticity

a measure of how much one economic variable responds to changes in another economic variable

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Price elasticity of demand

the responsiveness of the quantity demanded to a change in price

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How is price elasticity of demand measured?

percentage change in quantity demanded / percentage change in price

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What does PED always generate?

A negative number, presented in absolute value

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Elastic demand

percentage change in quantity demanded is MORE than the percentage change in price PED > 1
MORE responsive to a change in price
LESS tolerant of price increases

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Inelastic demand

percentage change in quantity demanded is LESS than the percentage change in price PED < 1
LESS responsive to a change in price
MORE tolerant of price increases

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Unit-elastic demand

percentage change in quantity demanded is equal to the percentage change in price PED = 1

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Perfectly elastic

the absolute value of price elasticity is equal to infinity, horizontal line

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Perfectly inelastic

the absolute value of the price elasticity is equal to 0, vertical line

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The midpoint formula

((Q2 - Q1) / average Q1,2) / ((P2 - P1) / average P1,2)

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When do we use the midpoint forumla?

to ensure we have only one value of the price elasticity of demand between the same two points on a demand curve

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Percentage change

yields a different amount depending on if the movement is up or down on the demand curve, issue is eliminated with the midpoint formula

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What are some key determinants of price elasticity of demand?

availability of close substitutes
passage of time
product - necessity or luxury
definition of the market
share of consumer’s budget accounted for by purchase

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Availability of close substitutes

more substitutes - higher PED (vending machine)
less substitutes - lower PED (gas)

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Passage of time

more time passes - higher PED
short-run - lower PED

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Product

luxury - higher PED (boat)
necessity - lower PED (bread)

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Market

narrow - higher PED (particular brand of green beans)
broad - lower PED (green beans in general)

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Budget accounted for by consumer

high % of budget - higher PED (rent)
low % of budget - lower PED (pencils)

Total Revenue

Price * Quantity

If demand is inelastic…

Increase in price = increase in total revenue
decrease in price = decrease in total revenue

if demand is elastic…

increase in price = decrease in total revenue
decrease in price = increase in total revenue

at higher prices demand is

elastic

at lower prices demand is

inelastic

unit-elastic

between elastic & inelastic

Revenue

total money in

Profit

money made

Cross-Price elasticity of demand

percentage change in quantity demanded of one good / percentage change in price of another good

If the products are substitutes CPED will be

positive (two brands of tablet computers)

If the products are complements CPED will be

negative (tablet computers & applications downloaded from online stores)

If the products are unrelated CPED will be

zero (tablet computers & peanut butter)

Income elasticity of demand

a measure of the unresponsiveness of quantity demanded to changes in income

Formula for IED

percentage change in quantity demanded / percentage change in income

If income elasticity of demand is positive & less than 1 the good is

normal & a necessity (bread)

If income elasticity of demand is positive & greater than 1 the good is

normal & a luxury (high-end jewelry)

If income elasticity of demand is negative the good is

inferior (high-fat meat)

Price elasticity of supply

the responsiveness of the quantity supplied to a change in price

formula for PES

percentage change in quantity supplied / percentage change in price = (always generate a positive number)

Determinants of the price elasticity of supply

the supply being elastic or inelastic depends on the ability and willingness of firms to alter the quantity they produce as price increases

if supply is elastic..

the value of price elasticity is greater than 1 MORE responsive to a change in price, price increases less

if supply is inelastic...

the value of price elasticity is less than 1 LESS responsive to change in price, price increases more

if supply is unit-elastic...

the value of price elasticity is equal to 1

if supply is perfectly elastic...

the value of price elasticity is equal to infinity horizontal line

if supply is perfectly inelastic...

the value of price elasticity is equal to zero vertical line