Theme 2.1: Part 2 - Elasticity of Demand and Supply Flashcards
Define “Price elasticity of demand”
Price elasticity of demand measures the degree of responsiveness of quantity demanded of a good to a change in its price, ceteris paribus
State the determinants of price elasticity of demand
Time to respond to price changes
Income (proportion)
Necessity (Degree)
Availability and closeness of substitutes
Note that Proportion of income is not the same as income
How does time to respond to price changes affect price elasticity of demand
In the short run:
Consumers are unable to immediately change their consumption patterns and habits, hence demand for the good tends to be more price inelastic
In the long run:
Consumers are able to gather more information such as the time in which price changes are going to last and to discover alternatives, hence price elasticity of demand will slowly become more price elastic
How does proportion of income affect the price elasticity of demand
If a large proportion of income is spent on the good, demand is more price elastic are consumers are more likely to find other chapter substitutes
If a small proportion of income is spent on the good, demand is more price inelastic as consumers are less sensitive to price changes.
How does degree of necessity of a good affect price elasticity of demand
High degree of necessity/adiction, more price inelastic
Low degree of necessity, consumers are able to cut back on the consumption of the good, hence demand is more price elastic
How does availability and closeness of substitutes affect price elasticity of demand
High availability of substitutes, demand more price elastic as consumers are more likely to turn to other substitutes
Low availability of substitutes, demand more price inelastic as there are limited number of alternatives
Example: petrol station in a isolated town vs petrol station in a city
Closer substitutes, demand for good is more price elastic\
Differentiated substitutes, no substitutes available, demand for good is more price inelastic
Example: Sugar of different brands vs perfume of different scents
How to calculate Total revenue
Total revenue = Price x Quantity
Define “Price elasticity of supply”
Price elasticity of supply measures the degree of responsiveness of quantity supplied of a good to a change in a change in its price, ceteris paribus.
State the determinants of price elasticity of supply
Production length and complexity
Excess stock levels
Substitutability and avaliability of input
Time to respond to price changes
How does production length and complexity affect price elasticity of supply
More lengthy and complex production process will result in more price inelastic supply (example: cars and planes)
Simple production process will result in more price elastic supply
How does availability and substitutability of input affect price elasticity of supply
If factors of production are easily available, supply is more price elastic as producers can easily switch resources and put it towards the creation of a product in demand (magazines and greeting cards can both be printed by a printed press)
If there are spare capacity to provide flexibility in reacting to market changes, supply will be more price elastic
How does excess stock level affect price elasticity of supply
When a good can be stored, supply of the good is more price elastic. Producers can react to price increase by increasing quantity supplied and can react to price decrease by holding back stocks.
How does production length and complexity affect price elasticity of supply
More lengthy and complex production process will result in more price inelastic supply (example: cars and planes)
Simple production process will result in more price elastic supply
How does time to respond to price changes affect price elasticity of supply
In the short run, supply is quite fixed (in most cases, capital is fixed), hence supply is more price inelastic. However, producers can change supply by employing more variable factors (usually labour)
In the long run, factors of production are all variable and supply becomes more price elastic
