Chapter 5 - Elasticity

Notes on Elasticity

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Chapter 5 ­ Elasticity
Price Elasticity of Demand
How much demand changes when there is a change in price.
% Change in Quantiy Demanded
% Change in Price
Factors that affect PEoD:
Number of Substitutes
o When high amount of substitutes, it is likely that the demand curve will be relatively
elastic. A small price rise would mean that a lot of consumers would switch to
cheaper alternatives. (This assume there is no loyalty shown to a brand)
o When low amount of substitutes, it is likely that the demand curve will be relatively
inelastic. A price rise would mean that consumers would have little choice when
trying to switch to cheaper alternatives, so many just carry on purchasing the good.
E.g. Car users when oil prices rise.
Time
o If consumers need the product they may accept the price rises, so demand in
unresponsive to price change in the short term.
In the longer term they may switch to cheaper alternatives, but may incur additional
expenses.
E.g. If oil-heating prices rose, consumers would continue to heat their houses,
however in the long term they may look at switching to alternatives such as gas or
solar power.
Necessity or Luxury?
o Necessities have an inelastic demand, as there are few substitutes to the product.
E.g. If petrol prices rise, consumers will continue to buy the product.
o Luxuries have an elastic demand, as there are more alternatives to the product.
E.g. If theme park prices rise, consumers may switch to going to the park.
Proportion of Income Spent on it
o If a small amount of income is spent on a product then it is likely that it has inelastic
demand. It has little effect on the standard of living.
o If a large amount of income is spent on a product then it is likely that it has elastic
demand. There is a larger opportunity cost.
When What is it What it means: Effect of firm's revenue
answer called: of a price cut:
is:
0 Perfectly There is no effect on demand when If prices fall, then
inelastic there is a price change. revenue falls (and vice
versa)
Between Price inelastic When prices fall, quantity demanded Revenue will fall
0 and -1 demand changes by a smaller proportion.
(Unresponsive to price changes)
1 Unitary price The change brings about the same Revenue will remain
elasticity of size effect on quantity demanded. constant
demand
Above 1 Price elastic When prices fall, quantity demanded Revenue will rise
demand changes by a larger proportion.
(Responsive to price changes)
Infinity Perfectly elastic When prices fall, quantity demanded If prices fall, then
demand becomes infinite. revenue hugely increase

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Chapter 5 ­ Elasticity
Price Elasticity and the Incidence of Taxes
If market forces aren't working then the government could intervene through taxes or subsidies.
The incidence of tax is the proportion of the tax which is passed onto consumers.
Discussing the effects of taxes can be split into 4 areas:
The effect on price
o Firms usually pass as much of tax onto consumers as they can.…read more

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Chapter 5 ­ Elasticity
Cross Price Elasticity of Demand
How much demand changes for `good B' when there is a change in price of `good A'.
% Change in Quantiy Demanded of Good B
% Change in Price of Good A
Substitutes have a positive XEoD; as prices fall of one good, demand falls for the other good.
It tends to be that the higher the XEoD, the closer substitutes they are.…read more

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