1.2: Elasticities

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    Definitions

     

    1. Price elasticity of demand (PED) is a measure of the responsiveness of the quantity demanded for a good or service to change in its price.
    2. Inelastic demand is where a change in price of a good or service leads to a proportionately smaller change in the quantity demanded of the good or service. PED value is between zero and one.
    3. Elastic demand is where a change in price of a good or service leads to a proportionately larger change in the quantity demanded of the good or service. PED value is greater than one.
    4. Cross elasticity of demand (XED) is a measure of the responsiveness of the demand for one good or service to a change in price of another good or service.
    5. Substitute goods are goods that can be used against each other, such as sugar or honey. Substitute goods have a positive cross elasticity of demand.
    6. Complementary goods are goods which can be used together, such as MP3 players and headphones. Complementary goods have a negative cross elasticity of demand.
    7. Income elasticity of demand (YED) is a measure of the responsiveness of the demand for a good or service to a change in income.
    8. Normal goods have positive income elasticity of demand. As income rises, the demand for the good increases.
    9. Inferior goods have negative income elasticity of demand. As income rises, the demand for the good decreases.
    10. Price elasticity of supply (PES) is a measure of the responsiveness of the quantity supplied for a good or service to a change in its price.
    11. Inelastic supply is where a change in price of a good or service leads to a proportionately smaller change in the quantity supplied of the good or service. PES value is between zero and one.
    12. Elastic supply is where a change in price of a good or service leads to a proportionately larger change in the quantity supplied of the good or service. PES value is greater than one.

    Price elasticity of demand (PED)

    • Measure of how much quantity demanded of a product changes when there is a change in price of a product.
    • PED = % change in quantity demanded of a product

    % change in price of a product

    • If PED = 0, change in price → No effect on quantity demanded → % change would be 0 → PED is perfectly inelastic.
    • If PED = infinity, change in price → Demand will fall to 0.
    • Normal goods have PED between 0 and 1.
    • Demand for commodities tend to be inelastic since they are scarce resources.
    • Demand for manufactured goods tend to elastic due to variety of choice presented to customers.

    ●       Three categories of PED

    ❖      Inelastic demand

    • Happens when PED is less than 1 and greater than 0.
    • Change in price → Proportionally smaller change in quantity demanded → Total revenue gained by the firm increases when price increases.

    ❖      Elastic demand

    • Happens when PED is less than infinity and greater than 1.
    • Change in price → Proportionally larger change in quantity demanded → Total revenue gained by the firm decreases when price increases.

    ❖      Unit elastic demand

    • Happens when PED = 1.
    • Change in price → Proportionate, opposite change in quantity demanded → Total revenue gained by the firm stays the same when price increases.

    ●       Determinants of PED

    ❖      Number and closeness of substitutes

    • More substitutes for a product → More elastic the demand for the product will be.
    • Products with fewer substitutes → Inelastic demand for the product.

    ❖      Necessity of the product and how widely the product is defined

    • Necessity products such as food, clothes → Demand is inelastic.
    • Products that are people’s wants → Demand is elastic.

    ❖      Time period considered

    • PED is inelastic in the short term and becomes more elastic in the long term.

    Cross elasticity of demand (XED)

    • Measure of how much the demand of the product changes when there is a change in price of another product.
    • XED = % change in quantity demanded of product X

    % change in price of product Y

    • If XED is positive, two goods, like wheat and rice, are substitute goods.
    • If XED is negative, two goods, like iPod and earphones, are complementary goods.
    • XED doesn’t change if two goods compared are unrelated to each other.

    Income elasticity of demand (YED)

    • Measure of how much the demand for a product changes when there is a change in consumer’s income.
    • YED = % change in quantity demanded of the product

    % change in customer’s income

    • If YED is positive, it is a normal good.
      • Low positive YED → Necessity good, such as food.
      • High positive YED → Superior good, such as luxury products.
    • If YED is negative, it is an inferior good.

     

    Price elasticity of supply (PES)

    • Measure of how much the supply of a product changes when there is a change in the price of the product.
    • PES = % change in quantity supplied of a product

    % change in price of the product

    • Same effects as PED but in this case, it is the supply of a product being impacted, rather than the demand.
    • Supply for commodities tend to be inelastic and manufactured goods tend to be elastic due to same reasons as mentioned in PED section.

    ●       Determinants of PES

    ❖      How much costs rise as output is increased

    • Rise in total costs → Producers doesn’t increase supply → PES is inelastic.
    • Existence of unused stocks, mobility of factors of production prevents a huge rise in costs for products.

    ❖      Time period considered

    • Same effects as PED, except the effects are on supply of the product, instead of demand of the product.

    ❖      Ability to store stock

    • High levels of stock → Firms tend to react quickly to price changes → PES of the product is elastic.

    Paper 3 Questions

     

    The price of meat increases by 10%, the quantity demanded of meat falls by 12% and the quantity of fish consumed increases by 9%.

     

    1. Calculate the price elasticity of demand (PED) for meat and state if the demand for meat is price elastic or inelastic.

    1. Calculate the cross-price elasticity for demand between meat and fish, and state what kind of products meat and fish are to each other.

    An individual’s income increased between $16,000 to $20,000. The spending on purchases of bread fell by 5% while the spending on purchases of food in general and eating out in restaurants increased by 15% and 30% respectively.

     

    1. Calculate the income elasticity for demand (YED) for each item and state the kind of item it is.