Exam: Elasticity Flashcards
- Price Elasticity of Demand/Supply - Applications & Importance
What is the price elasticity of demand?
A concept that measures the sensitivity or responsiveness of quantity demanded to a change in the price of a good or service.
Describe the relationship between price and quantity demanded
There is a negative relationship between price and quantity demanded. An increase in price will cause the quantity demanded to contract and vice versa
Why is the price elasticity of demand important?
- Elasticity is convened with the question of how much.
- It allows us to consider real life examples which illustrate the relationship the between price and quantity demanded.
- This info is useful to firms, economists, consumers and the government.
What is the formula for PED?
The formula for price elasticity of demand is % change in QD / % change in price.
What do the results of the PED formula indicate?
- If the value is above 1, then demand is said to be price elastic.
- If the value is less than 1, than demand is said to price inelastic
- If the value is equal to 0, than demand is said to be perfectly inelastic and price changes don’t affect quantity demanded.
Identify the determinants of PED?
- Availability of substitutes.
- Necessity vs luxury
- Time
- Proportion of income
- Definition of the Market
Describe the availability of substitutes
The greater the number of substitutes a good has, the more price elastic demand is.
Goods with many close substitutes will be relatively elastic, while goods with few substitutes will be relatively inelastic.
Describe necessity vs luxury
Necessary goods such as bread and milk tend to be more inelastic than luxury type goods such as designer handbags and luxury sports cars because they are necessary and consumers will continue to buy them even as prices rise.
Describe definition of the market
The demand for a broad category of good will always be more inelastic than the demand for a single brand.
Provide an example of definition of the market
An example of this is petrol (broad) overall is inelastic, but the demand for a single brand of petrol (BP) will be elastic because there are close substitutes
Describe proportion of income spent
Expensive items tend to be relatively price elastic because they take up a larger proportion of a consumer’s income
Cheap, inexpensive items tend to be price inelastic items.
If a good takes up a higher proportion of income they are likely to change demand when price changes.
Describe time
If consumers have time to respond to a price change, then demand will be more price elastic.
In the short run, demand for most goods will be relatively inelastic because consumers don’t have much time to adjust their consumption or find substitute products.
What is a price elastic good?
- Small change in its price leads to a significant change in the quantity demanded.
- Luxury goods, non-essential items, or goods with many substitutes often have elastic demand. They are goods that consumers can live without or delay purchasing
- A small increase in price can lead to a large drop in the quantity demanded.
- The more substitutes there are, the more elastic demand is likely to be.
- Price elastic demand is known for its high responsiveness as demand responds relatively quickly to price changes.
What is a price inelastic good?
- A change in price leads to a relatively small change in the quantity demanded.
- Necessities like basic food items, fuel, and medicine often have inelastic demand.
- Even if the price increases, consumers will still buy roughly the same amount because these goods are essential.
- The fewer substitutes there are, the more inelastic the demand is likely to be.
- Known for its low responsiveness, demand doesn’t change much with price fluctuations.
What is total revenue?
The price of a good multiplied by the quantity sold.
Describe the relationship between price elasticity of demand and total revenue?
When demand is elastic, a decrease in price leads to a significant increase in quantity demanded, raising total revenue
When demand is inelastic, a price increase results in only a small decrease in quantity demanded, which leads to a higher total revenue.
Why is understanding the relationship between PED and TR so important?
Understanding the relationship between price elasticity of demand and total revenue helps business make pricing decisions to maximise their revenue.
What is price elasticity of supply?
The concept of price elasticity of supply measures the responsiveness of quantity supplied to a change in the price of a good or service.
Describe the relationship between price and quantity supplied
There is a positive relationship between price and quantity supplied. An increase in price will cause quantity demanded to increase and vice versa.
Why is the price elasticity of supply important?
Elasticity is convened with the question of how willing producers are to supply more.
Price elasticity measures the strength of the law of supply for a particular good or service.
What is price elastic supply?
A small change in price leads to a relatively larger change in quantity supplied.
The elasticity coefficient is greater than 1.
Producers can increase production quickly
Inputs are easily available
There is excess production capacity
The time period is long, giving producers time to adjust.
What is price inelastic supply?
A change in price leads to a relatively smaller change in the quantity supplied.
The elasticity coefficient is less than 1.
Production cannot be easily increased due to limited resources or capacity.
The good takes time to produce
There are high barriers to adjusting output
The time period is short, meaning producers do not have enough time to react.
Identify the determinants of PES
- Time
- Nature of Industry
- Ability to Store Inventories
What is time (supply)
The more time a producer must respond to a change in price, the more supply elastic the good tends to be.
In the short run, a producer is usually unable to increase the amount available for sale. However, as time passes most goods become more supply elastic.
