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25 Cards in this Set
- Front
- Back
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MICRO: Price Elasticity of Demand (PED)
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[insert equation here]
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Explain the concept of price elasticity of demand, understanding that it involves responsiveness of quantity demanded to a change in price, along a given demand curve
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PED is a measure of the responsiveness of the quantity of a good demanded to change in its price. PED is calculated along a given demand curve. In general, if there is a large responsiveness of quantity demanded, demand is referred to as being price elastic; if there is a small responsiveness, demand is price inelastic
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State that the PED value is treated as if it were positive although its mathematical value is usually negative
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Since price and quantity demanded are negatively (indirectly) related, the PED is a negative number. The common practise is to drop the minus sign and consider PED as a positive number (taking the absolute value)
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Explain, using diagrams and PED values, the concepts of price elastic demand, price inelastic demand, unit elastic demand, perfectly elastic demand and perfectly inelastic demand
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Value of PED Classification Interpretation
0<PED < 1 Inelastic Demand Quantity demanded is relatively unresponsive to price 1<PED < ∞ Elastic Demand Quantity demanded is relatively responsive to price Special Cases PED = 1 Unit Elastic Demand Percentage change in quantity demanded equals percentage change in price PED = 0 Perfectly Inelastic Demand Quantity demanded is completely unresponsive to price PED = ∞ Perfectly Elastic Demand Quantity demanded is infinitely responsive to price |
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Explain the determinants of PED, including the number and closeness of substitutes, the degree of necessity, time and the proportion of income spent on the good
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Number and closeness of substitutes: the more substitutes a good (or service) has, the more elastic is its demand.
The closer two substitutes are to each other, the greater the responsiveness of quantity demanded to a change in the price of the substitute Necessities vs Luxuries: the demand for necessities is less elastic than the demand for luxuries Length of time: the longer the time period in which a consumer makes a purchasing decision, the more elastic the demand Proportion of income spent on good |
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Explain why PED varies along a straight line demand curve and is not represented by the slope of the demand curve
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On any downward-sloping, straight-line demand curve, demand is price-elastic at high prices and low quantities, and price-inelastic at low price and large quantities. At the midpoint of the demand curve, there is unit elastic demand. Therefore, the terms 'elastic' and 'inelastic' should not be used to refer to an entire demand curve (with the exception of the three special cases where PED is constant throughout the entire demand curve).
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Examine the role of PED for firms in making decisions regarding price changes and their effect on total revenue
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When demand is elastic, an increase in price causes a fall in total revenue, while a decrease in price causes a rise in total revenue.
When demand is inelastic, an increase in price causes an increase in total revenue, while a decrease in price causes a fall in total revenue. When demand is unit elastic, a change in price does not cause any change in total revenue |
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Explain why the PED for many primary commodities is relatively low and the PED for manufactured products is relatively high
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Many primary commodities have a relatively low PED (price inelastic demand) because they are necessities and have no substitutes (for example, food and oil). The PED of manufactured products is relatively high because they usually have substitutes
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Examine the significance of PED for government in relation to indirect taxes
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If governments are interested in increasing their tax revenues, they must consider the PED of the goods to be taxed. The lower the price elasticity of demand for the taxed good, the greater the government tax revenues
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MICRO: Cross Price Elasticity of Demand (XED)
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Cross Price Elasticity of Demand and its Determinants
[insert equation here] |
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Outline the concept of cross price elasticity of demand, understanding that it involves responsiveness of demand for one good (and hence a shifting demand curve) to a change in the price of another good
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Cross-price elasticity of demand (XED) is a measure of the responsiveness of demand for one good to a change in price of another good, and involves demand curve shifts. It provides us with information on whether demand increases or decreases, and on the size of demand curve shifts
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Substitute Goods
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Substitutes: XED for two goods is positive when the demand for one good and the price for another good change in the same direction: when price of one increase, the demand for the other also increases. This occurs when the two goods are substitutes.
The larger the XED, the greater the substitutability between two goods, and the larger the demand curve shift in the vent of a price change |
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Complementary Goods
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Complementary goods: XED for two good is negative when the demand for one good and the price of the other good change in opposite directions: when the price of one good increases, the demand for the other falls. This occurs when the two goods are complements.
The larger the absolute value of the negative XED, the greater is the complementarity between two goods, and the larger is the demand curve shift in the event of a price change |
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Examine the implications of XED for businesses if prices of substitutes or complements change
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▫ Substitutes produced by a single business
▫ Substitutes produced by rival businesses ▫ Substitutes and mergers between firms ▫ Complementary goods |
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MICRO: Income Elasticity of Demand (YED)
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[insert equation here]
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Outline the concept of income elasticity of demand, understanding that it involves responsiveness of demand (and hence a shifting demand curve) to a change in income
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YED is a measure of the responsiveness of demand to changes in income, and involves demand curve shifts. It provides information on the direction of change of demand given a change in income (increase or decrease) and on the size of the change (size of demand curve shifts)
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Show that normal goods have a positive value of YED and inferior goods have a negative value of YED
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YED>0 income elasticity of demand is positive when demand and income change in the same direction. A positive YED indicates that the good in question it normal. Most goods are normal goods.
YED<0 a negative income elasticity of demand indicates that the good is inferior: demand for the good and income move in opposite directions. Examples include bus rides, second-hand clothes and used cars |
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Necessities (YED<1)
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YED<1: necessities, if a good has a YED that is positive but less than one, it has income inelastic demand: a percentage increase in income produces a smaller percentage increase in quantity demanded, necessities are income inelastic goods
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Luxuries (YED>1)
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YED>1: luxuries, if a good has a YED that is greater than one, it has income elastic demand: a percentage increase in income produces a larger percentage increase in quantity demanded. Luxuries are income elastic goods
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Examine the implications for producers and for the economy of a relatively low YED for primary products, a relatively higher YED for manufactured products and an even higher YED for services
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The higher the YED for a good or service, the greater the expansion of its market is likely to be; the lower the YED, the smaller the expansion
YED and the economy: every economy has three sectors: 1. Primary Sector (agriculture, forestry, fishing etc.) 2. Manufacturing Sector 3. Services Sector (entertainment, travel, health care, education etc.) With economic growth, the relative size of the three sectors usually changes over time, and these are due to YED. |
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MICRO: Price Elasticity of Supply (PES)
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[insert equation here]
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Explain the concept of price elasticity of supply, understanding that it involves responsiveness of quantity supplied to a change in price along a given supply curve
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Price elasticity is a measure of the responsiveness of the quantity of a good supplied to changes in its price. PES is calculated along a given supply curve. In general, if there is a large responsiveness of quantity supplied, supply is referred to as being elastic; if there is a small responsiveness, supply is inelastic.
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Explain, using diagrams and PES values, the concepts of elastic supply, inelastic supply, unit elastic supply, perfectly elastic supply and perfectly inelastic supply
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▫ Supply is price inelastic when PES<1.
▫ Supply is price elastic when PES>1 ▫ Supply is unit elastic when PES=1 ▫ Supply is perfectly inelastic when PES=0 ▫ Supply is perfectly elastic when PES = ∞ |
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Explain the determinants of PES, including time, mobility of factors of production, unused capacity and ability to store stocks
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Length of time
Mobility of factors of production Spare (unused) capacity of firms Ability to store stocks |
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Explain why the PES for primary commodities is relatively low and the PES for manufactured products is relatively high
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In general, primary commodities usually have a lower PES than manufactured products. The main reason is the time needed for quantity supplied to respond to price changes. In the case of agriculture, it takes a long time for resources to be shifted in and out of agriculture. Farmers need at least a planting season to be able to respond to higher prices.
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