Economics - Elasticity

Unit 1 revision on elasticity - AS level Economics AQA

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  • Created by: Clodagh
  • Created on: 12-04-13 14:59
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  • Elasticity
    • DEFINITION: A measure of responsiveness of the quantity demanded to a change in one of the factors influencing demand
    • Price Elasticity of Demand (PED)
      • Measures how responsive demand is to changes in price
      • Relatively elastic would mean a large change in demand
      • Relatively inelastic would mean a small change in demand
      • FORMULA: %change in QD divided by %change in P
        • REMEMBER: You have to Q before you P!
      • The law of demand states that as price falls, quantity demanded increases. There is an inverse relationship
        • PED will therefore be negative
          • PED is inelastic when the value lies between 0 and -1
          • PED is elastic when the value is between -1 and -?
      • When PED = 0, there is perfectly inelastic demand. This is represented by a vertical demand curve
        • When the   PED =  -?, the demand curve is horizontal as it is perfectly elastic
      • Unitary elastic demand occurs when the PED = -1. The significance is that the percentage fall in quantity demanded is the same as the percentage change in price
      • It's influences include it's degree of necessity, habit-forming goods, substitutes and time
        • Necessary products have inelastic demand as consumers tend to buy them regardless of price
        • Products such as tobacco tend to have price inelastic demand, as their buyers see them as necessary
        • Substitutes are products with close alternatives which have elastic demand
        • In the short run, consumers may not be able to find alternatives and so demand remains the same (perfectly inelastic) but over a long period of time, they become more price elastic
      • If demand is elastic, then a fall in price leads to increased total revenue
        • If demand is inelastic, then a fall in price leads to decreased total revenue
    • Income Elasticity of Demand (YED)
      • FORMULA: %change in QD divided by %change in Y
      • For normal goods there is a positive relationship between income and quantity demanded, as higher incomes give more spending power to consumers
      • Income elasticity of demand is usually positive
      • Richer people buy more luxuries and so luxury products tend to have higher (more elastic) income elasticities of demand
      • As incomes rise, people will buy fewer economy products, such as cheap cuts of meat
        • These products are known as inferior goods and have a negative income elasticity of demand
    • Cross Elasticity of Demand (XED)
      • FORMULA: %change in QD of good Y divided by P of good X
      • Complements: Where products are consumed together, such as petrol and cars
        • An increase in the price of one product will lead to lower demand for the other product
          • There is an inverse (negative) relationship
      • Substitutes: Where consumers choose between two substitutes, such as Pepsi and Coke
        • An increase in the price of one product will lead to lower demand for the same product, but higher demand for the other
          • There is a positive relationship
      • Complements have negative XED. A high negative value suggests the two products are close complements
    • Price Elasticity of Supply (PES)
      • FORMULA: %change in QS divided by %change in P
      • As price rises there is an increase in the quantity supplied
        • This is a positive relationship and means the PES is also usually positive
      • PES is inelastic if the value lies between 0 and 1
        • PES is elastic when the value is greater than 1
      • There is perfectly inelastic supply when PES = 0 and this is represented by a vertical supply curve
        • There is perfectly elastic supply when PES = ? and this is represented by a horizontal supply curve
      • Unitary elastic supply occurs when PES = 1 and this is depicted as a straight supply curve at a 45 degree angle
      • It is influenced by time, spare capacity and ease of switching products
        • If a price rises, it may take time to increase production because firms need to employ new resources. In the short run, supply cannot be extended much, even if the price rises a lot, so supply is inelastic
        • If a factory has under-used machinery or workers, it can react quickly to higher prices and so it's PES is elastic
        • If it is easy to switch manufacturing from one product to another, then supply i elastic

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