Chapter 6 Unit 3
Elasticity
Income elasticity of demand
Insights
Insights to economy
Recessions
High impact on High income-elasticity coefficients
Ei = percentage change in quantity demanded divided by percentage change in income
Responsiveness of consumers to a change in their incomes by buying more or less of a particular good
Understand Normal goods and inferior goods
Inferior goods
Higher income means lower demand
Ei = negative
Normal goods
Higher income means higher demand
Ei = positive
Value varies greatly
Cross elasticity of demand
Application
Government and firms decisions
Mergers
Lower prices or not
Exy = Persentage change in quantity demanded of product X divided by percentage change in price of product Y
How sensitive consumers purchases of a product X are to change to a change in price of an other product Y
Understand substitute and complementary goods
Independent goods
Cross elasticity is zero or near zero
Complementary goods
Cross elasticity is negative
Substitute goods
Cross elasticity of demand is positive
Firms
Total Revenue Test
Unit Elasticity
Increase or decrease of price wil not effect TR
Inelastic Demand
Price increase wil increase TR
Price decrease wil reduce TR
Elastic Demand
Price increase wil reduce TR
Price decrease wil increase TR
Total amount the sellers receives from the sale of a product in a particular time period.
TR = Product price multiplied by quantity sold
Elasticity of supply
Price elasticity of supply
Price elasticity and formula
Simplest way to calculate
Mid-point formula
Es is never negative
Price and quantity supplied are directly related
Interpretations of Es
Extreme cases
Perfectly elastic supply
Ed = Infinite
Perfectly inelastic supply
Ed = 0
Unit elastic
Es=1
Inelastic supply
Es < 1
elastic supply
Es > 1
Es =( change in quantity supplied divided by (sum of quantities supplied divided by 2) ) divided by (change in price divided by (sum of prices divided by 2) )
Applications of price elasticity of supply
Volatile Gold prices
Antiques and reproductions
Degree of price elasticity of supply
How easily/ quickly producers can shift resources between alternative users
The easier it is the greater the elasticity of supply
Impact of time
Immediate market period
Length of time producers are unable to respond to price changes
Long run
Long enough to adjust plant sizes or for new firms to enter.
Short run
Too short to change plant capacity but long enough to use the fixed-sized plant more intensively
Equilibrium price is lower than in the immediate market period
Elastic supply
Large change in quantity supplied
Sensitive to price change
Inelastic supply
Small change in quantity supplied
Insensitive to price change
Elasticity of Demand
Price elasticity of demand
Applications of price elasticity of demand
Decriminalisation of illegal drugs
Excise Taxes
Large crop yields
Determinants of Price elasticity of demand
Time
Luxuries versus necessities
Proportion of Income
Substitutability
Price elasticity and formula
Price elasticity along a Linear demand curve
TR curve
First it slopes upward then reaches a maximum then it slopes downward
demand curve
Straight line
Simplest way to calculate Ed
Mid-point formula
Elimination of minus sign
Downward sloping curve of Demand
Ed =( change in quantity divided by (sum of quantities divided by 2) ) divided by (change in price divided by (sum of prices divided by 2) )
Interpretations of Ed
Inelastic demand
Ed < 1
Elastic demand
Ed > 1
Extreme cases
Perfectly elastic demand
Ed = Infinite
Perfectly inelastic demand
Ed = 0
Unit elasticity
Ed = 1
Inelastic demand
Insensitive to price changes
Small change in quantities demanded
Elastic demand
Sensitive to price change
Large change in quantities demanded