Elasticities

Question 1

Elasticity

Answer 1

Responsiveness of one variable to changes in another

Question 2

Elastic

Answer 2

Change in one produces a larger change in the other

Question 3

Inelastic

Answer 3

Change in one produces a smaller change in another

Question 4

Price elasticity of demand?

Answer 4

Responsiveness of the quantity demanded to a change in price

Question 5

How to calculate PED?

Answer 5

Percentage change in QD/ Percentage change in price

Omit the minus sign always

Question 6

Perfectly price inelastic demand?

Answer 6

PED = 0
Change in price has no effect on QD
Vertical demand curve

Question 7

Price inelastic demand

Answer 7

PED > 0 but PED <1
Price causes a less than proportional change in QD

Question 8

Price elastic demand

Answer 8

PED > 1
Price cases a more than proportionate change in QD

Question 9

Unit elastic demand

Answer 9

PED =1
Price causes same but opposite % change in QD

Question 10

Use of PED

Answer 10

Can be used to assess the impact of a price change on total revenue.

Question 11

Relationship between PED and total revenue

Answer 11

1. When demand is price elastic, a fall in price leads to a rise in total revenue.
2. When demand is price inelastic, a fall in price leads to a fall in total revenue.
3. When demand is unit elastic, total revenue stays the same regardless of price changes.

Question 12

Determinant of PED

Answer 12

1. Availability and closeness of substitutes – more substitutes and closer ones means that demand will be price elastic.
2. Marker width -> the narrower the market definition, the more demand will be price elastic.
3. The time period -> PED is more inelastic in the short term and elastic in long erm as it takes time for consumers to change their patterns.
4. Method of payment e.g. auto added to bill.
5. Necessity of the good from consumer perspective -> if it is deemed a necessity then demand will be price inelastic.
6. Expense of the good in respect to income: goods which represent a small share tend to have more price inelastic demand.

Question 13

Income elasticity of demand (YED)

Answer 13

Responsiveness of demand for a good to a change in consumer income

Question 14

How to calculate YED?

Answer 14

% change in QD/ % change in income
Sign ( + or -) is important

Question 15

Positive YED

Answer 15

Normal goods > consumer incomes increase, demand increases

Question 16

Negative YED

Answer 16

Inferior goods > Consumer incomes increase, demand will increase

Question 17

Normal and inferior goods

Answer 17

A good can be both, it depends on consumer incomes and how people value things

Question 18

If YED is greater than 1 or less than -1

Answer 18

Demand is income elastic

Question 19

If YED is between 1 and -1

Answer 19

Demand is income inelastic

Question 20

Luxury (superior) goods

Answer 20

Usually have a high positive YED (2+)

Question 21

If YED is = 0

Answer 21

Demand is unresponsive to changes in consumer income

Question 22

Uses of YED

Answer 22

Gives indication for businesses

High YED = Demand is sensitive = risky to invest

Question 23

Cross-price elasticity of demand (XED)

Answer 23

Measures the responsiveness of demand for one good to a change in demand for another

Question 24

How to calculate XED?

Answer 24

% Change in QD for good X/ % Change in price of good Y

Question 25

If XED = 0 then?

Answer 25

The goods are independent, there is no effect on each other

Question 26

If XED is positive?

Answer 26

Goods are substitutes, the larger the value the stronger the substitute

Question 27

If XED is negative?

Answer 27

Goods are complements, the larger the value the stronger the complement

Question 28

If XED is between +1 and -1

Answer 28

XED is price inelastic

Question 29

If XED is more than +1 and less than -1?

Answer 29

XED is price elastic

Question 30

What does XED show?

Answer 30

Impact of your own and competitors price changes on yours and your competitors goods demand and revenue.

Question 31

If XED is high and positive ?

Answer 31

Price cuts can be used to steal market shares from rival firms, but dangerous if prices are increased.

Question 32

How can XED give an insight on complementary goods?

Answer 32

Can show the impact of price changes and how to then maximise revenue

Question 33

Price Elasticity of supply

Answer 33

Measures the responsiveness of quantity supplied to a change in price of a good

Question 34

How to calculate PES?

Answer 34

% Chane in quantity supplied/ % change in price

Question 35

PES is always...?

Answer 35

Positive As price rises, quantity supplied rises as it leads to an increase in profit potential

Question 36

Perfectly price inelastic supply

Answer 36

PES = 0 Vertical supply curve

Question 37

Perfectly price elastic supply

Answer 37

PES = Infinity Horizontal supply curve

Question 38

Price inelastic supply

Answer 38

PES > 0 but PES < 1 (Change in price creates a less than proportional change in supply)

Question 39

Price elastic supply

Answer 39

PES > 1 (Change in price creates a more than proportional change in quantity supplied)

Question 40

Straight line passing through the origin has a PES of ...?

Answer 40

1

Question 40

Unitary price elastic supply

Answer 40

PES =1 (Change in price creates same change in quantity supplied)

Question 41

(1) Determinants of PES

Answer 41

More substitutes = Higher PES

Question 42

(2) Determinants of PES

Answer 42

Longer time frame Price elastic - firms can adjust their resources to change output Shorter production time means supply will be more price elastic

Question 43

(3) Determinants of PES

Answer 43

More stock and factors of production available (spare capacity or labour) the more supply will be price elastic

Question 44

(4) Determinants of PES

Answer 44

More total costs rise, the more supply will be price inelastic

Question 45

Uses of elasticities

Answer 45

Firms planning or decisions for investment/hiring. Decision on price strategies – whether to increase or decrease prices. Competitor pricing decision Recession means inferior goods booms - Luxury good firms suffer. Taxation  Effects of indirect taxes and subsidies Changes in exchange rates => The impact of changes in the exchange rate on demand for imports and exports Government intervention -> may intervene in market by introduction minimum or maximum prices e.g., minimum price for alcohol. Elasticity of demand supply also affects operation of the price mechanism as a means of rationing scarce goods and services among competing uses and in determining how producers respond to the incentive of a higher market price.