LECTURE 4 - Elasticity Flashcards
(17 cards)
define elasticity
a measure of the responsiveness of quantity demanded or quantity supplied to a change in one of its determinants
consumers buy more when price is low, income is high, price of a substitute is high or when the prices of complements are lower
define price elasticity of demand
a measure of how much the quantity demanded of a good responds to a change in the price of that good
computed as percentage change in quantity demanded divided by the percentage change in price
what is meant when a good is said to be elastic or inelastic
elastic - if the quantity demanded responds substantially to changes in the price
inelastic - if the quantity demanded responds slightly to changes in the price
what influences the price elastcity of demand
- availability of close substitutes
- necessities vs luxuries
- definition of the market
- time horizon
how does availabiity of substitutes affect the price elastcity of demand of a good
goods with close substitutes tend to have more elastic demand because it is easier for consumers to switch from that good to another
e.g. a small increase in the price of butter, assuming the price of margarine is held fixed, causes the uantity of butter sold to fall by a large amount. by contrast, because eggs are a food without a substitute, the demand for eggs, is less elastic than the demand for butter
how does necessities vs luxuries affect the price elasticity of demand for a good
necessities tend to have inelastic demands, whilst luxuries ten to have elastic demands.
whether a good is determined or luxury depends o the preference of the buyer
how does the definition of the market affect the price elasticity of demand of a good
the elasticity of demand in any market depends on how we draw the boundaries of the market. narrowly defined markets tend to have more elastic demand than broadly defined markets because it is easier to find substitutes for narrowly defined goods.
broad markets e.g. food. narrow markets e.g. ice cream
how does the time horizon affect the price elasticity of demand of a good
goods tend to have more elastic demand over a longer time horizons.
e.g. when the price of oil rises, the quantity of oil demanded falls only slightly in the first few months. however over time, people buy more fuel efficient cars, switch to public transportation etc. within several years, the quantity demanded falls more substantially
how do you compute price elasticity of demand
PED = % change in quantity demanded / % change in price
always report PEDs as positive numbers
how do you compute price elasticity of demand using the midpoint method
USED TO COMPUTE PED BETWEEN TWO POINTS ON A DEMAND CURVE
(P2 - P1) / [(P2 + P1) / 2]
Q1 = QUANTITY DEMANDED OF POINT A
Q2 = QUANTITY DEMANDED OF POINT B
P1 = PRICE OF POINT A
P2 = PRICE OF POINT B
how is price elasticity of demand interpreted
- demand is considered elastic when the elasticity is greater than 1
- demand is considered inelastic when elasticity is less than 1
- if the elasticity is exactly 1 then demand is said to have unit elasticity
the flatter the demand curve that passes through a given point, the greater the price elasticity of demand. vice versa.
what does a perfectly inelastic demand look like on a graph
- vertical line
- elasticity = 0
[insert graph]
what does inelastic demand look like on a graph
- steep gradient
- elasticity is less than 1
[insert graph]
what does unit elasticity look like on a graph
- usually straight diagonial line
- elasticity equals 1
[insert graph]
what does elastic demand look like on a graph
- shallow line
- elasticity is greater than 1
[insert graph]
what does perfectly elastic demand look like on a graph
- horizontal line
- elasticity equals infinity
[insert graph]
what are the other demand elasticities
- income elasticity of demand
- cross-price elasticity of demand
