elasticity

Elasticity

Price Elasticity of Demand Measures the responsiveness of the quantity demanded of a good to a change in price. Who uses PED Suppliers – will decreasing/increasing price cause a change in QD Government & Minister of Finance – VAT & Excise Duties Monopolist – see how far they can raise prices until they become elastic. •

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PED Formula

( - Negative) = Goods which obey Law of Demand = Normal Goods

-∞ Perfectly elastic

-1 Unitary elastic

( + Positive) = Goods which don’t obey Law of Demand

0 Perfectly Inelastic

P D

Q

P

D

Q

P

D

Q

P

D Q

Inelastic Demand: The percentage change in demand is less than the percentage change in price P

D Q

Factors that Effect PED

2004 HL

2004 HL

2004 HL

2010 (B)

Income Elasticity of Demand (YED) = measures the responsiveness of Quantity demanded to a change in Normal Goods = Positive Income Inferior Goods = (- Negative)

0

Inelastic/ Necessity

1

Elastic / Luxury

Inferior Goods (- Negative)  –  the  the demand for these goods fall when Income Rises e.g. Tesco Value Normal Goods (Positive +) –  the  the demand for these goods Increases when Income Rises e.g. Flat screen TV

YED Formula •

∆ ∆

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1+2 1+2

YED Calculation 2009

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As the Goods are Positive this means they are Normal = If Income Falls , QD will Fall

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The good has a YED of 2.5 which is greater than 1 which means it is Elastic.

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Therefore If Income fell by 1% , QD would fall 2.5 times that amount.

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We can see income fell by 8% therefore , QD would fall 2.5 times that amount = 20% Sales were 100,000 and have fallen by 20% = 20,000

Total Sales = 100,000  –  20,000  20,000 = 80,000

Cross Elasticity of Demand = measures the responsiveness of the Quantity demanded of one good to change in price of another good •

∆  ∆  

×

 1 +2    1 +2  

Negative = Complements

Positive= Substitutes

0 Complements = goods sold together e.g. IPods & Earphones Substitutes = goods that act as alternatives for each other e.g. Pepsi & Coke

Cross Elasticity of Demand Positive = Substitutes e.g. If the Price of tea rises , then the

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quantity demanded of coffee coffee rises as consumers substitute to now relatively cheaper coffee. coffee. •

NB The Bigger the Number the Closer the Substitute.

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Negative = Complements, Negative relationship between •

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the price of good a and good B, e.g. if the price of shoes rise, the quantity demanded of shoelaces will fall. fall. NB The Bigger the Negative Number the Closer C loser the Complement.

Result of ZERO = No Relationship e.g. price of Coffee and QD of potatoes

Cross Elasticity of Demand – 2011 SQ

CW: A consumer buys 10 units of Good A when the price of Good B is €5.

When the price of Good B rises to €6 (the price of Good A remaining unchanged) the consumer buys 14 units of Good A. (i) Define cross elasticity of demand. (ii) Using an appropriate formula, calculate this consumer’s cross elasticity of demand for Good A. Show your workings. (iii) Is Good A a substitute for, or a complement to, Good B? Explain your reasoning

Price Elasticity of Supply •

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PES measures the responsiveness of Quantity Supplied to a change in price. Formula •

∆  ∆

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 1+ 2  1+ 2

2 Results either Positive = as Price rises QS will Rise (max revenue) or as price falls QS will fall (switch to other goods) Large No. = very responsive to a price change (Elastic) Small No. = not very responsive to to a price change (Inelastic) Zero = producer cannot or does not respond to a price change. Here Supply = Perfectly Inelastic •

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Factors effecting PES 1. Capaci Capacity ty of the sup suppli plier er – if the firm is operating at full capacity, then it may not be able to increase supply in response to the price rise. In this case, supply would be inelastic 2. Le Leng ngth th of ti time me – A farmer producing potatoes and carrots could take a full year to respond. If the price of carrots rises it will take the farmer a year to reallocate potato fields to carrots – the longer the length of time to respond the more elastic the supply. 3. Na Natu ture re of of the the prod produc uctt – e.g. a fisherman may have a catch of fish to sell. If the price of fish falls he or she will still wish to supply the fish, even at a lower price as the product is perishable. Perishable products will therefore have an inelastic supply. 4. Mobi Mobility lity of fact factors ors of Pro Producti duction on – the supplier can easily switch his or her resources towards supplying the good which has gone up in price, then supply is elastic. 5. Factors outside the firm’s control –  If there is a strike by staff or a disruption in the supply of raw materials or a bad harvest in farming, there is little a supplier can do to increase supply in response to a price

2007 SQ

2006

2006

2003

2003