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ELASTICITY - Coggle Diagram
ELASTICITY
Total revenue test
TR is the total amount the seller receives from the sale of a product in a particular time period..
-Calculated by product price X quantity sold.
TR=P X Q
Elasticity demand
-If demand is elastic, a decrease in price increases total revenue. A lower price is received per unit, additional units are sold to makeup for the lower price.
-A price increase reduces total revenue. The revenue gained from a higher price per unit will be more than offset from the revenue lost from the lower quantity sold.
Inelastic demand
-Price decrease reduces total revenue.
-A price increase increase's total revenue.
-Percentage change in quantity demanded is less then the percentage change in price.
Unit elasticity
-An increase/decrease in price leaves total revenue unchanged.
-Loss in revenue from lower unit price will be offset against gain in revenue from accompanying increase in sales.
-When price changes, total revenue remains constant, demand is unit-elastic and the percentage change in quantity equals the percentage change in price.
Income elasticity of demand:
Measures the degree to which consumers respond to a change in their incomes by buying more or less of a particular good.
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Law of demand:
Consumers will buy more of a product when its price declines and less when its price increases.
Consumers' responsiveness to a price change is measured by a product's price elasticity of demand.
Eg. restaurant meals where consumers are responsive to price changes-
Modest price change causes very large changes in quantity purchased. The demand for such products is relative elastic or simply
elastic.
Eg. toothpaste where consumers pay less attention to price increases-
Substantial price changes causes small changes in quantity purchased. The demand for such products is relatively inelastic or simply
inelastic.
The Price Elasticity Co-Efficient Formula:
-Degree to which price is elastic/inelastic measured by economists.
Percentage Change
(Change in quantity demanded / original quantity demanded) /
(Change in price / original price)
Why use percentages?
-If we use absolute changes, choice of units will arbitrarily affect our impression of buyers responsiveness.
-Correctly compare responsiveness to changes in the prices of different products.
Ignore the minus sign in the coefficient of price elasticty of demand and show only the absolute value.
Using averages
Midpoint formula simply averages the two prices and the two quantities.
Application's of price elasticity of demand:
-Large crop yields.
-Excise taxes.
-Decriminalization of illegal drugs.
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Price elasticity of supply:
If quantity supplier by producers is relatively responsive to price changes, supply is elastic.
Degree of price elasticity depends on how quickly and easily producer's can shift resources between alternative uses.
Immediate market period is a length of time over which producers are unable to respond to a change in price with a change in quantity supplied.
Cross elasticity of demand:
-Measures sensitivity of consumers purchases of one product (call it X) to a change in the price of another product (call it Y).
-Cross elasticity of demand allows us to quantify and more fully understand substitute and complementary goods
Substitute goods
Complementary goods
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Cross elasticity is negative, increase in the price of one leads to the decrease in the price of other.
Cross elasticity is positive, sales of X moves in the same direction as a change in the price of Y.
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Interpretations of Ed
Elastic demand: Demand is elastic if a specific percentage change in the price denominator results in a larger percentage change in quantity demanded in the numerator.
Inelastic demand: Demand is inelastic if a specific percentage change in the price denominator results in a smaller percentage change in quantity demanded in the numerator.
Unit elasticity:
Percentage change in price and the resulting percentage change in quantity is the same.
Extreme cases;
-Price change results in no change in quantity demanded, demand is thus perfectly inelastic.
-Small price reduction causes buyers to increase their purchases from zero to all they can obtain, the coefficient is infinite and thus demand is perfectly elastic.
Determinants of price elasticity of demand
Substitutability: The more substitute goods, the greater the price elasticity of demand.
Proportion of income: The higher the price relative to consumers incomes, the greater the price elasticity of demand.
Luxuries versus necessities: Price elasticity of demand is higher for luxury goods than for necessities.
Time: Product demand is more elastic over long periods of time.