Topic 3: Elasticity Flashcards
(27 cards)
Define PED
Price Elasticity of demand (PED) refers to the degree of responsiveness of quantity demanded of a good o a change in the price of the good itself, ceteris paribus
How to calculate PED?
PED = % change in quantity demanded/ % change in price
What does it mean if |PED|>1?
Demand is price elastic, a change in price will result in a more than proportionate change in quantity demanded.
E.g Air travel for leisure travellers
What does it mean if 0<|PED|<1?
Demand is price inelastic, change in price will result in less than proportionate change in quantity demanded. E.g Rice in for Asian societies
What does it mean if |PED| = infinity?
Demand is perfectly price elastic, change in price will result in quantity demanded to fall to 0.
E.g Homogenous goods in perfectly competitive market
What does it mean if |PED| = 0
Demand is perfectly price inelastic, change in price will lead to no change in quantity demanded.
E.g Patient’s demand for drugs with no substitutes
What does it mean if |PED|=1?
Demand is unitary elastic, change in price will result in equal change in quantity demanded.
What are the determinants of PED?
Time Period, Proportion of income, Number of Substitutes, Degree of Necessity
How does the number of substitutes affect PED?
A good with more close substitutes will have more price elastic demand because it is easier for consumers to switch away from consuming that good to others.
How does the degree of necessity of the good affect PED?
The degree of necessity of a good refers to how strongly the consumer needs the good. If the degree of necessity of the good Is high, the demand of the good will be more price inelastic, even if price increases, consumers cannot easily reduced he quantity demanded of the good.
How does the proportion of household income spent on the good affect PED?
The greater the proportion of income spent on purchasing the good, the more price elastic the demand of the good. This is because a rise in the price of these goods would take up a more significant proportion of their income.
How does time period consideration affect PED?
The longer the time period after a price change, the more price elastic the demand is likely to be. This is because in the longer term, consumers have more time and think of more ways to adapt their consumption patterns and find substitutes
How do you find producer revenue/consumer expenditure?
Price x Quantity
How does PED affect producer’s revenue/consumer’s expenditure?
When the demand of the good is relatively price inelastic, a fall in supply results in a large rise in price and a less than proportionate decrease in quantity, since revenues gained from the increase in price outweighs the revenue loss from the fall in quantity, the producer’s revenue is higher.
However, if demand is relatively price elastic, the rise in price will lead to a more than proportionate decrease in quantity demanded. Hence revenues gain due to rise in price is less than revenue loss due to all in demand. Hence, producer’s revenue decreased.
Define PES
Price elasticity of supply refers to the degree of responsiveness of quantity supplied of a good to a given change in the price of the good itself, ceteris paribus.
How to calculate PES?
PES = % change in quantity supplied/ % change in price
What does it mean if PES>1?
Supply is price elastic, a given change in price brings about a more than proportionate change in quantity supplied.
E.g Canned Food
What does it mean if 0<PES<1?
Supply is price inelastic, a given change in price brings about a less than proportionate change in quantity supplied.
E.g Agriculture goods
What does it mean if PES = infinity
Supply is perfectly price elastic, producers are willing to sell at whatever quantity they want at the given price.
What does it mean if PES = 0?
Supply is perfectly price inelastic, a fixed quantity that the producer must sell regardless of the price.
Eg. concert performance in a fixed capacity venue
Determinants of PES
Factor Mobility of FOPs, Inventory Level, Nature of Good, Time Period, Spare Capacity
How does time period for producers to adjust production affect PES?
In the very short run:
All FOPs are fixed in supply, hence even if price increases, the producers are unable to increase the quantity supplied, hence the supply is perfectly price inelastic.
In the short run:
Production is restricted by at least one fixed FOP, hence, if there is an increase in price for the final good, the production can still continue, but it is done through the variable factor, hence, supply is relatively price inelastic.
In the long run:
All FOPs are variable hence, an increase in price will allow producers to increase their quantity by more than proportionate as they can use FOPs efficiently to produce the quantity of the good corresponding to the price.
How does level of stocks/inventories affect PES?
If the level of stocks of finished products is high, a producer can easily respond to a rise in price by releasing those stocks into the market for sale. However, the ability of a producer to be able to keep the stocks is also dependent on the ease of keeping the stocks.
How does availabiliy of spare capacity affect PES?
If the firm has plenty of spare capacity in terms of FOP, such as dormant or underutilised machinery, an increase in price will result in the producer being able to respond readily by utilising idle machinery to increase quantity, hence the supply of the good will be price elastic.
