Year 1 Microeconomics - Elasticity/D/S Flashcards

Question

weak vs strong substitutes xed

Answer 1

If goods are weak substitutes, there will be a low cross elasticity of demand. Example, if the price of The Daily Mail increases 10%, the demand for the Financial Times may only increase by 1%. Therefore, the cross elasticity of demand is 0.1. These two newspapers are weak substitutes. If two goods are close substitutes, there will be a high cross-elasticity of demand. Example, if the price of Sainsbury’s flour increases 10%, demand for Hovis flour may increase by 20%. To consumers, there is little difference between the two goods. Therefore, the cross elasticity of demand is +2.0

Answer 2

🛍️ 1. Availability of Substitutes → If a good has many close substitutes (e.g. Pepsi vs Coke) → Consumers can easily switch when price rises → Demand becomes more price elastic → Small price changes lead to larger changes in quantity demanded ⏳ 2. Time Period → In the short run, consumers may find it hard to change habits → So demand tends to be more inelastic initially → But over time, they adjust and find alternatives → Demand becomes more elastic in the long run 🏠 3. Necessity vs Luxury → Necessities (e.g. insulin, rent) are needed regardless of price → So their PED is inelastic → Luxuries (e.g. designer clothes, holidays) are more responsive to price → Demand is more elastic as consumers can cut back 💸 4. Proportion of Income Spent on the Good → If a good takes up a large proportion of income (e.g. car, rent) → Consumers are more sensitive to price changes → Demand tends to be more elastic → With cheaper, low-income-share goods (e.g. salt), PED is more inelastic 🧠 5. Brand Loyalty and Habitual Consumption → Strong brand loyalty (e.g. Apple, cigarettes) means consumers ignore price → Demand becomes more inelastic → Even price increases don't significantly affect quantity demanded

Answer 3

🔧 1. Spare Capacity → Firms with spare capacity (idle resources, machinery) → Can increase output quickly when price rises → Supply is more responsive to price changes → Therefore, PES is elastic 🏭 2. Production Time → If production takes a long time (e.g., wine, construction) → Firms cannot quickly respond to rising prices → Supply changes slowly despite price rises → Therefore, PES is inelastic 🔄 3. Stock Levels → Firms that can store unsold goods (e.g., canned food) → Can release stock quickly when prices rise → Supply increases in the short run → Therefore, PES is more elastic 🛠️ 4. Factor Substitutability → If labour and capital can be easily reallocated → Firms adjust production more easily when prices rise → Increases responsiveness of supply → So PES is more elastic 🌍 5. Time Period → In the short run, firms have limited flexibility → But in the long run, they can invest and expand → Supply becomes more responsive to price over time → PES tends to be more elastic in the long run

Answer 4

🍞 Necessities vs Luxuries Necessities (e.g. bread, toothpaste) tend to have a low YED, often between 0 and 1 ➡️ As income rises, demand only increases slightly because consumers already purchase enough ➡️ Luxuries (e.g. designer clothing, holidays) have a high YED (greater than 1) ➡️ ⏩ Therefore, the more luxurious a good is, the more income elastic its demand will be 🔁 Availability of Substitutes If a good has many substitutes, rising income may lead consumers to switch to higher-quality alternatives ➡️ This makes the original good's demand more income elastic, especially if it’s an inferior good ➡️ For example, as income rises, people may switch from public transport to private cars ➡️ ⏩ The good being substituted away from will have a negative YED, showing it’s inferior 👥 Proportion of Income Spent Goods that take up a small portion of income (e.g. salt, matches) tend to be income inelastic ➡️ Even large income changes don’t significantly affect the quantity demanded ➡️ For goods taking up a large income share (e.g. cars, housing), demand is more sensitive to income changes ➡️ ⏩ The greater the proportion of income spent, the more income elastic the demand tends to be 🌍 Level of Development in the Country In low-income countries, basic necessities may be more income elastic as people move out of poverty ➡️ In contrast, in high-income countries, these same goods are already widely consumed ➡️ Therefore, further income rises have minimal effect on demand ➡️ ⏩ So the same good can have different YED values depending on a country’s level of development 🧠 Consumer Perception of the Good If a product is perceived as a status symbol, it will often have a higher YED ➡️ This is because rising income leads people to signal wealth by consuming more of these goods ➡️ Think of high-end watches or branded tech – demand increases faster than income ➡️ ⏩ Strong branding and social value can increase income elasticity

Answer 5

🟩 1. Closeness of Substitutes If two goods are close substitutes (e.g. Pepsi and Coca-Cola), consumers can easily switch between them. This makes XED positive and high, as a price change in one leads to a large change in demand for the other. The closer the substitutes, the greater the sensitivity in demand. So, industries with close competitors tend to face high XED values. 🟩 2. Necessities vs Luxuries Necessities (e.g. bread) have fewer or weaker substitutes, leading to a low XED. Luxuries or non-essential goods (e.g. designer clothes) tend to have more substitutes, increasing XED. Consumers of necessities are less likely to switch when prices rise. Therefore, XED is often lower for essentials. 🟩 3. Branding and Product Differentiation Strong branding makes products seem unique, even if substitutes exist. This reduces consumers’ tendency to switch → lower XED. The more differentiated a product, the more inelastic the cross-demand. E.g. iPhones vs other phones – brand loyalty lowers XED. 🟩 4. Time Period In the short run, consumers might not respond quickly to price changes due to habit or lack of information. Over time, they find alternatives, making XED more elastic in the long run. This time lag affects how cross demand reacts to price shifts. Therefore, XED tends to rise over time.

Answer 6

💰 1. Price of the Good If the price of a good rises → Consumers may no longer be willing or able to afford the same quantity → Quantity demanded falls (contraction of demand) → Movement along the demand curve 📉 🧺 2. Income of Consumers (Normal Goods) If consumer incomes increase → They have more disposable income to spend → Demand for normal goods increases → Demand curve shifts to the right 📉 3. Income of Consumers (Inferior Goods) If income increases → Consumers switch to higher-quality alternatives → Demand for inferior goods falls → Demand curve shifts to the left 🔁 4. Price of Substitutes If the price of a substitute (e.g. Pepsi) rises → Consumers switch to the relatively cheaper good (e.g. Coca-Cola) → Demand for the cheaper substitute increases → Demand curve shifts to the right 👫 5. Price of Complements If the price of a complement (e.g. printers) rises → Demand for the related good (e.g. ink cartridges) also falls → Because goods are consumed together → Demand curve shifts to the left 🧠 6. Changes in Consumer Tastes and Preferences If a good becomes more fashionable or desirable → Consumers are more willing to buy it at any given price → Demand increases regardless of price → Demand curve shifts to the right 🌍 7. Population Size If the population increases → There are more potential buyers in the market → Total market demand rises → Demand curve shifts to the right

Answer 7

⚙️ 1. Cost of Production If production costs (e.g. wages, raw materials) rise → Profit margins shrink at each price level → Firms reduce supply to maintain profitability → Supply curve shifts to the left 📉 📈 2. Technological Advances If new technology improves productivity → Output increases using the same inputs → Firms can supply more at each price → Supply curve shifts to the right ⚡ 💰 3. Indirect Taxes If the government imposes a higher indirect tax (e.g. VAT) → Costs of production rise → Firms supply less at each price → Supply curve shifts to the left 📉 🎁 4. Subsidies If the government provides a subsidy → Production becomes cheaper for firms → Firms are incentivised to increase output → Supply curve shifts to the right 💷 🌾 5. Natural Conditions / Shocks If poor weather affects agriculture or a shock (e.g. war) disrupts production → Output falls due to external constraints → Less can be supplied at each price → Supply curve shifts to the left ⛈️ 🏭 6. Number of Producers in the Market If more firms enter the industry → Overall market supply increases → Greater competition and output → Supply curve shifts to the right 🧑‍🏭🧑‍🏭 🔮 7. Expectations of Future Prices If firms expect prices to rise in the future → They may withhold current supply to sell later at a higher price → Current supply decreases → Supply curve shifts to the left ⏳

Answer 8

**PRICING STRATEGIES** 1️⃣ If PED is elastic (PED > 1): A small increase in price → large fall in quantity demanded ⟶ Total revenue falls ⟶ Firm may lower price to boost sales ⟶ Lower price → proportionally larger rise in demand → higher total revenue 2️⃣ If PED is inelastic (PED < 1): A price increase → smaller fall in quantity demanded ⟶ Total revenue rises ⟶ Firm can raise prices to maximise revenue ⟶ Suitable for necessities or addictive goods (e.g. petrol or cigarettes) 3️⃣ Helps firms decide whether to enter price wars: If demand is elastic and rivals cut prices → firm may have to follow ⟶ Otherwise lose market share ⟶ But if demand is inelastic, firm can maintain or increase prices ⟶ Without significant loss of customers 4️⃣ Influences cost-plus pricing decisions: If demand is inelastic, firms have more power to set high mark-ups ⟶ Less risk of losing customers ⟶ If elastic, high mark-ups may reduce sales significantly ⟶ Encourages firms to focus on cost control or value pricing 📢 PED and Non-Pricing Strategies: 1️⃣ Product differentiation in elastic markets: Demand is price-sensitive → cutting price not ideal ⟶ Firm improves quality, branding or features ⟶ Makes demand more inelastic over time ⟶ So future price changes have less impact on quantity demanded 2️⃣ Advertising to reduce elasticity: Adverts can increase consumer loyalty or perceived uniqueness ⟶ Shifts demand to become more inelastic ⟶ Allows firm to charge higher prices without losing many customers ⟶ Builds brand loyalty and increases revenue stability 3️⃣ Improving customer service: Makes product experience better and harder to substitute ⟶ Reduces elasticity (more brand loyalty) ⟶ Less likely to switch to rivals on small price changes ⟶ Non-price competition becomes key to retaining demand 4️⃣ Loyalty schemes in highly elastic markets: Encourages repeat purchases even when prices change ⟶ Helps firm maintain customer base ⟶ Reduces price sensitivity gradually ⟶ Can avoid price wars with competitors

Answer 9

💸 YED and Pricing Strategies: 1️⃣ High YED (Luxury goods): When income rises → demand rises more than proportionally ⟶ Firms can increase prices as consumers become less price-sensitive ⟶ Higher profit margins can be achieved during economic growth ⟶ E.g., luxury car brands can use premium pricing to signal quality 2️⃣ Low YED (Necessities): Income changes have little effect on demand ⟶ Pricing must stay competitive since volume won’t grow much with income ⟶ Firms may use cost-plus pricing to maintain steady margins ⟶ E.g., supermarkets focus on operational efficiency 3️⃣ Negative YED (Inferior goods): Rising incomes → falling demand ⟶ Firms should avoid increasing prices even when incomes rise ⟶ May need to cut prices to maintain sales ⟶ Or diversify product range to include normal goods 4️⃣ Helps forecast revenue based on income trends: In a boom, luxury firms may raise prices ⟶ In a recession, firms selling necessities or inferior goods may keep prices stable or lower ⟶ Avoids demand collapse during downturns 📢 YED and Non-Pricing Strategies: 1️⃣ Product positioning based on YED: High YED → market as exclusive, aspirational (luxury branding) ⟶ E.g., Rolex uses prestige advertising to attract high-income buyers ⟶ Helps build brand identity and justify high prices 2️⃣ Diversification to reduce YED risk: If firm relies on high YED goods → vulnerable in recession ⟶ Firm might launch low-YED products to spread risk ⟶ E.g., car brands like Mercedes offering entry-level models (A-Class) 3️⃣ Targeted advertising based on income group: High YED → ads target high-income consumers (e.g., via luxury magazines) ⟶ Low YED or inferior goods → ads target price-sensitive or low-income markets ⟶ Ensures the right message reaches the right audience 4️⃣ Geographical expansion based on income trends: Firms may enter high-income markets for luxury goods ⟶ Or focus on lower-income regions for inferior goods ⟶ Aligns with consumer purchasing power and income trends

Answer 10

💸 XED and Pricing Strategies: 1️⃣ Competing with substitutes (XED > 0): If two goods are close substitutes → high positive XED ⟶ A rival’s price fall → leads to large fall in demand for your product ⟶ Firm may need to lower its own prices to stay competitive ⟶ E.g., Pepsi may cut prices in response to Coca-Cola promotions 2️⃣ Weak substitutes (XED ≈ 0): Price changes in rival products don’t affect demand much ⟶ Firm has greater pricing freedom ⟶ Can increase prices without major loss in market share ⟶ Useful for slightly differentiated brands 3️⃣ Complements (XED < 0): If price of complementary good rises → demand for firm’s product falls ⟶ E.g., rise in fuel prices → fall in demand for cars ⟶ Firm may lower its own prices or bundle products to retain demand ⟶ Protects sales volume even when complement becomes expensive 4️⃣ Strategic pricing bundles: Low price on one good boosts demand for its complement ⟶ Printer firms sell printers cheaply, but ink is expensive ⟶ XED helps identify which product to price lower to maximise overall revenue ⟶ Used in razor/blade, console/games models 📢 XED and Non-Pricing Strategies: 1️⃣ Brand loyalty to reduce substitutability: Strong branding makes customers view products as less substitutable ⟶ Reduces positive XED with rivals ⟶ Firm is less vulnerable to competitor price cuts ⟶ E.g., Apple retains customers despite high Android competition 2️⃣ Product differentiation to weaken substitute links: If firm makes its product unique → reduces impact of rival’s price cuts ⟶ Demand becomes less cross-elastic ⟶ Allows more stable pricing strategy ⟶ E.g., organic snacks vs. regular snacks 3️⃣ Joint ventures and partnerships for complements: Firms with complementary products can collaborate (e.g., Spotify & Samsung) ⟶ Boosts joint demand ⟶ Reduces the risk of sales falling due to a price change in the complement ⟶ Enhances cross-selling opportunities 4️⃣ Monitoring rivals' pricing behaviour: If firm knows XED is high with a specific competitor ⟶ Can track price changes closely and react instantly ⟶ Protects market share and avoids surprise losses ⟶ Important in oligopolistic markets

Year 1 Microeconomics - Elasticity/D/S Flashcards

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