# 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
• 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