Elasticity and Market Efficiency

Question 1

what is price elasticity of demand?

Answer 1

Price elasticity of demand is defined as the responsiveness of quantity demanded to a change in the price of the good or service.

Question 2

What is the formula for the Percentage Change Method for finding Elasticity of Demand?

Answer 2

Ed = percentage change in quantity / percentage change in price

Question 3

What is the other formula for Point Method?

Answer 3

Ed = ∆ Q / Q x P/∆P

Question 4

What is the formula for Midpoint method?

Answer 4

Ed = ∆Q / Q(average) x P(average) / ∆P

Question 5

What is the advantage of using the midpoint method

Answer 5

it does not depend on which price we choose as the starting price as we are calculating the elasticity along the same segment of the demand curve.

Question 6

Draw the graph for elastic and inelastic demand on your book

Answer 6

on book

Question 7

What is perfect inelasticity?

Answer 7

When price elasticity is equal to 0, then change in price will have no effect on the quantity demanded. The demand curve for perfectly inelastic is vertical.

Question 8

What is perfect elasticity?

Answer 8

Perfect elasticity is where the demand curve is horizontal, meaning price elasticit is infinity

Question 9

What does the steepness of the demand curve show about elasticity

Answer 9

The steeper the demand curve, the lower the elasticity (more inelastic) and the flatter the demand curve, the higher the elasticity.

Question 10

What is the formula for Total revenue?

Answer 10

TR = P x Q

Question 11

What are the determinants of price elasticity of demand

Answer 11

1. Availability of substitutes: Greater number of close substitutes good has, more price elastic its demand.
2. Whether good is necessity or a luxury: Basic items such as food are more price inelastic than luxury type goods. This is because they are essential while luxuries are not.
3. Definition of the market: Demand for good in broadly defined market will be more inelastic than the demand for a good in a narrowly defined market. For all goods, the price elasticity of a single brand is greater than the price elasticity of the good in general.
4. Proportion of income spent: Expensive goods likely to be relatively price elastic as they take up larger proportion of consumers income. E.g. increase in price of lollies from $0.50 to $0.75 unlikely to cause significant decrease in quantity demanded of coffee. However, tv increase from $3000 to $4000, quantity demand change significantly.
5. Time: If consumers have time to respond to time change, demand = more price elastic. Different in short term to long term. If petrol prices jump to very high levels, consumers cannot change thier consumption in short run. However, if price of petrol remains high over longer period, people find substitutes such as public transport.

Question 12

What is price elasticity of supply

Answer 12

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

Question 13

What is the formula

Answer 13

Same as for the elasticity of demand, however, we change quantity demanded with quantity supplied.

Question 14

what are the determinants of price elasticity of supply

Answer 14

1. time: If producer can respond quickly to price change, supply is price elastic.
2. nature of industry:E.g. agricultural products such as wheat or meat take long time to produce, if price of wheat suddenly increase, farmer cannot quickly respond, must wait for next growing season. Manufactured goods on the other hand are easy to make, firms can respond quickly + expand output of products in response to change in price.
3. Ability to store inventories: If producer has ability to store or warehouse its goods, can respond fairly quickly to a change in demand and so supply would be relatively elastic.