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Economics > Section 3: Elasticity of Demand > Flashcards

Section 3: Elasticity of Demand Flashcards

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1
Q

What is Elasticity of Demand

A

This is the measure of the degree of responsiveness of the quantity demanded of a good or service to changes in the determinant of demand

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2
Q

The 3 determinants of demand are

A

-price of the good
-consumer’s income
-price of other goods

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3
Q

What do the 3 determinants of demand give rise to

A

3 main measures of elasticity of demand

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4
Q

the 3 main measures of elasticity of demand are

A

-price elasticity of demand
-income elasticity of demand
-cross elasticity of demand

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5
Q

What is Price Elasticity of Demand

A

This can be defined as a measure of the degree of responsiveness of the quantity demanded of a product or service to changes in its price

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6
Q

How is Price Elasticity of Demand calculated

A

PED= percentage change in QD/ percentage change in price

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7
Q

Percentage change in QD calculation

A

(New QD-Original QD)/Original QD x100

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8
Q

Calculation for percentage change in price of the good

A

yk what it is

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9
Q

Interpretation for
PED= infinity

A

This means the good is perfectly price elastic in demand. This means that a % change in the price of the good will lead to an infinite change in the QD of the good. Goods that are deemed to be perfectly price elastic have a horizontal DC. (check book for diagram)

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10
Q

PED=0

A

The good is perfectly price inelastic in demand. This means that a % change in the price of a good will lead to no change in the QD of the good. The DC for such good is vertical.

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11
Q

Example of a perfectly price inelastic in demand good

A

salt

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12
Q

PED=1

A

The good has unitary price elasticity in demand. This suggests that a % change in price results in a proportionate change in QD. Eg. a 10% change in the price of the good will lead to a 10% change in the QD of the good.

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13
Q

0<PED<1

A

The good is relatively price inelastic in demand. This means that a change in the price of the good results in a less than proportionate % change in QD. Eg. a 10% change in the price of the good leads to a 5% change in the QD of the good. Goods that are relatively price inelastic in demand have a DC that is steeply sloped.

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14
Q

1<PED<infinity

A

This means that the good is relatively price elastic in demand. A change in the price of the good will cause a more than proportional change in the QD of the good. Eg. a 10% change in the price of the good will lead to a 20% in the demand of the good. Goods that are relatively price elastic in demand have a DC that is gently sloped.

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15
Q

In PED, The steeper the DC, the…

A

greater the price inelasticity of demand

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16
Q

In PED, the flatter (more gently sloped) the DC,…

A

the greater the price elasticity of demand

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17
Q

When classifying and interpreting the good (in PED), only what is looked at

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A

the absolute value (the sign is ignored)

18
Q

What are factors affecting the PED

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A

1.Number of Substitutes
2. Nature of the Good
3. Addictiveness

19
Q

Number of Substitutes

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A

The greater the number of substitutes available, the greater the price elasticity of demand
The smaller the no. of substitutes available, the greater the price inelasticity of demand

20
Q

Nature of the Good

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A

Necessity goods are deemed to be relatively price inelastic in demand
Luxury goods are relatively price elastic in demand

21
Q

Addictiveness

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A

The more addictive a product tends to be, the greater the price inelasticity of demand, and thus a smaller PED value
The less addictive a good is, the greater the price elasticity of demand, and the larger the PED value

22
Q

Uses of the PED (1)

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A

Used in formulating price strategies
-If PED is calculated and the demand for the good is found to be relatively price elastic, the firm should lower the price of the good as this would result in an increase in the QD of the good by a more than proportionate amount resulting in an increase in total revenue and profit margin of the firm

-If a firm determines their good to be relatively price inelastic in demand, the firm should increase the price of their good as the QD would fall by a less than proportionate amount resulting in an increase in revenue and profit for the firm

23
Q

Uses of the PED (2)

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A

Useful to government taxation authorities in setting taxes on goods and services
-Increase taxation revenue, the taxation authorities of country would choose to increase taxes on goods that are relatively price inelastic in demand

24
Q

Interpretation outline (for when it is relatively…)

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A

(good) can be classified as relatively price (in)elastic in demand as the PED value lies between (value). This means that a % change in the P of (good) results in a more/less than proportionate change in the QD of (good) by (the consumer/s). For example, a 10% increase in the P of (good) would result in a (value)% decrease in QD which would be represented by an upward movement along the DC, termed a contraction in demand. Conversely, a 10% decrease in the P of (good) would result in a (value)% increase in the QD which would be reflected by a downward movement along the DC termed an extension in demand.

25
What is Income Elasticity of Demand
This is a measure of the degree of responsiveness of the % change in demand for a good or service arising due to a % change in consumer's income.
26
YED formula
YED= %change in D for the good/ %change in consumer's income
27
Why is the YED for a good calculated
in order to determine whether a good is normal or inferior. It is also used to determine whether a good is income elastic or income inelastic.
28
YED=positive interpretation
When the coefficient of the YED for a good is positive, the good is said to be normal. This means that there is a positive relationship between consumers' income and their demand for the g/s. An increase in consumers' income will lead to an increase in demand for the good, shown by an outward shift of the DC. Conversely, a decrease in consumers' income will lead to a decrease in the demand for the good, shown by an inward shift of the DC.
29
YED=negative
When the coefficient of the YED for the good is negative, this means the good is inferior. There is a negative relationship between consumers' income and demand for the good, i.e, an increase in consumers' income will lead to a decrease in their demand for the good, shown by an inward shift of the DC. Conversely, a decrease in consumers' income will lead an increase in their demand for the good, shown bu an outward shift of the DC.
30
0
The good is said to be relatively income inelastic in demand. This means that a change in consumers' income will result in a less than proportionate change in their demand for the good, eg. a 10% change in consumers' income will cause a 3% change in their demand for the good.
31
1
The good is deemed to be relatively income elastic in demand. This means that a %change in consumers' income will cause a more than proportionate change in their demand for the good. For eg. a 10% change in consumers' income will result in a 20% change in their demand for the good
32
Uses of YED (get ready)
To determine production levels -During periods of boom and peaks when productivity levels are high and there is a lot of Y circulating in the economy, the demand for normal goods would increase while the demand for inferior goods would fall. If a firm knows the type of good it is producing by calculating the YED, they will choose to increase production of normal goods and decrease production of inferior goods -Conversely, during times of recession and downturns in the economy when production and Y levels are low, the demand for inferior goods is high while the demand for formal goods is low. It would help for the firm to calculate the YED for their goods so they can adjust production levels to increase their supply of inferior goods and decrease their supply of normal goods.
33
YED interpretation outline
(good) can be classified as a (normal/inferior) good and relatively Y in/elastic in demand, as the coefficient of the YED is (+ve/-ve) and as the YED lies between (value) and (value). As (s) is a (normal/inferior) good, there is a (+ve/-ve) relationship between (consumer)'s Y and their demand for (good). Additionally, as it is deemed to be relatively price in/elastic in demand, a % change in (consumer)'s Y will result in a proportionate change in her D for (good). For example, a 10% increase/decrease in (consumer)'s would lead to a (value)% increase/decrease in her D for (good), reflected by an outward/inward shift of the DC. Inversely,...
34
Cross Elasticity of Demand definition
This is a measure of the degree of responsiveness of the % change in demand for one good, good A, to a % change in the price of the other good, good B.
35
XED formula
XED= %change in D for good A (the good)/ % change in the P of the other good (good B)
36
XED=positive
this means that the goods are substitutes. they have a positive relationship with each other. this means that an increase in the price of the other good causes a decrease in D for the good, shown by an outward shift of the DC. Conversely a decrease in the price of the other good causes a decrease in D for the good, shown by an inward shift of the DC for the good.
37
XED=negative
The 2 goods are said to be complementary goods as they have a negative XED value. They are thus used hand in hand. An increase in the P of the other good results in a decrease in D for the good, shown by an inward shift of the DC for the good. Conversely,
38
0
The 2 goods are said to be relatively cross inelastic in demand. this means a change in the P of the other good will lead to a < proportionate % change in D for the good. For example a 10% change in the P of the other good will cause a 5% change in D for the good
39
1
the goods are deemed to be relatively cross elastic in D. this means that a % change in the P of the other good leads to a > proportionate change in D for the good. For example, (use 10% and then 20%)
40
XED interpretation outline (check book)
-state goods -state type of goods -+ve/-ve XED and how they can be used -elasticity -lies between values -proportionality -example and relation to sotdc for the good

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