Economics - Elasticity

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Elasticity - Various

Elastic Demand: A good with many close substitutes tends to have an elastic demand. Because buyers are easily able to switch between substitutes, they are relatively sensitive to price changes.

Inelastic Demand: A good with very few close substitutes tends to have an inelastic demand. Because buyers are not able to switch between substitutes, they are not very sensitive to price changes.

PED - Price Elasticity of Demand

PED Calculation example data:

Price of good x - last year £35 / this year £45

Qty demanded of good x - last year £6000 / this year £4000

Average consumer income last year £23000 / this year £25000

Price of good y - last year £20 / this year £30

PED Calculation: (using above data)

Quantity change X (4000-6000)/[(4000+6000)/2]=-0.4

Price change

X (45-35)/[(45+35)/2]=0.25

PED of X -0.4/0.25 = -1.6

PED Calculation result interpretation

-VE = tells us PED for this product is elastic. A percentage price

change means a greater percentage quantity of demand change.

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IED - Income Elasticity of Demand

IED Calculation: (using above data)

Quantity

change X (4000-6000 )/[(4000+6000)/2]=-0.4

Average

consumer Income change (25000-23000 )/[(23000+25000)/2]=0.083

IED -0.4/0.083= -4.81927711

IED Calculation result interpretation

-VE = tells us IED for this product is elastic. A negative number

suggests this is an inferior good.

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CROSS Price Elasticity between Goods X and Y

CPE Calculation: (using above data)

Quantity

change X (4000-6000)/[(4000+6000)/2]=-0.4

Price Change good Y

(30-20)/[(20+30)/2]=0.4

Cross price elasticity

-0.4/0.4= -1

CPE Calculation result interpretation

-VE = complimentary - The cross price

elasticity between X and Y is negative and suggests that goods X and Y are

complimentary goods.

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Elasticity - Definitions etc

Name the types of elasticities of demand that there are to

consider.

* Ped

* Xed

* Yed

Define PED.

PED is a measure of how much the quantity demanded of a product

changes when there is a change in the price of the product. Elasticity measures the responsiveness of one variable to a change in another.

The price elasticity of demand depends on neither the units used to measure price nor the units used to measure quantity.

If the PED for an item is estimated at 1.3, it means that a 1% increase in the price of the item will decrease the quantity of the item demanded by 1.3%

Consumer behaviour - ie expected demand by product type (elastic v inelastic)

Consumers are strongly attached and loyal to the product. = inelastic

Many close substitutes are available for the product = elastic

The product is a luxury product = elastic

The product accounts for only a small fraction of a consumer’s weekly expenditure = inelastic

Impact of a Price Change

1) If Ped is equal to 0, then a change in the price of a

product will have what kind of effect on the quantity demanded?

A change in price will have no effect.

2) If Ped is equal to infinity, then a change in the price of a

product will have what kind of effect on the quantity demanded?

A change in price will lead to a greater than proportionate

change in the quantity demanded of it.

To Raise Revenue (Inelastic and Elastic)

If a firm has inelastic demand for its product, to raise

revenue they should..?

Raise the price of the product.

If a firm has elastic demand for its product, to increase

revenue they should..?

Not raise the price.

Define 'XED'.

A measure of how much the demand for a product changes when

there is a change in the price of another product.

What is the difference between the range of values for Ped

& Xed?

Ped can be anything from 0-infinity:

Ped = 1 > 0 - inelastic;

Ped = > 1 - Elastic.

Xed can be any value and is either positive or negative:

+ive - 2 Gs are substitutes;

-ive - 2 Gs are compliments.

0 - 2 Gs are unrelated.

Define 'YED'.

A measure of how much the demand for a product change when

there is a change in the consumer's income.

State the values that YED can have and their significance.

Yed can be +ive & -ive.

When Yed = 0-1, it's

inelastic.

When Yed

Necessity Gs - Low income elasticity.

Superior Gs - High Y elasticity.

Inefrior Gs - Yed is -ive.

Name 3 determinants of Ped.

1. No. & closeness of substitutes.

2. Necessity of the product & how widely it is defined.

3. Time period considered.

Define 'PES' (Price Elasticity of Supply).

A measure of how much the supply of a product changes when

there is a change in its price.

What is the range of values adoptable by Pes?

0 - infinity, and aren't hypothetical like Ped.

When PES = 0, a change in the price of the product will have

what effect on the quantity supplied?

No effect on the quantity supplied.

When PES is infinite (perfectly elastic), if price falls,

what effect will it have on the supply of the product?

The supply of the product will fall to 0, an infinite

change.

When the value of PES is less than 1 and more than 0, a

change in price leads to..

..a less than proportionate change in the quantity supplied

of it.

(inelastic supply)

When the value of PES is greater than 1 and less than

infinity, a change in the price leads to..

..a greater than proportionate change in the quantity

supplied of it.

(Elastic supply)

Define 'unit elastic supply'.

The value of PES is 1, and a change in price leads to a

proportionate change in the quantity supplied of it.

What are the two determinants of PES?

1. How much costs rise as output is increased.

2. Time period considered.

Collusion

- may be a feature of an oligopolistic market. Explain what is meant by ‘collusion’

- definition = Rival sellers in the industry come together for their mutual benefit

- Collusive practices may be undermined by price wars.

Price Wars

Outline two benefits of price wars for the consumer.

1. Lower prices / value for money

a. Consumers will benefit from the availability of commodities at lower prices.

b. Consumers will be able to get better value for their limited income.

2. Higher disposable income

With lower prices consumers will now have a higher disposable income resulting in a better

standard of living.

3. More choice

As consumers now have a greater disposable income they can choose how to spend this

additional income.