Chap6- Elasticity

• What is elasticity in economics?

  Elasticity measures how responsive demand or supply is to a change in price.
• What does the price elasticity of demand (PED) indicate?

  PED indicates the responsiveness of demand to a change in price.

  
• What is the formula for price elasticity of demand?

  PED = % change in quantity demanded / % change in price

  
• What characterizes a price elastic good?

  A price elastic good is very responsive to a change in price, with PED having a numerical value > 1.
• What defines a price inelastic good?


  A price inelastic good has demand that is relatively unresponsive to price changes, with PED having a numerical value < 1.
• What is a unitary elastic good?


  A unitary elastic good has a change in demand equal to the change in price, with PED = 1.
• What characterizes a perfectly inelastic good?


  A perfectly inelastic good has demand that does not change when price changes, with PED = 0.
• What defines a perfectly elastic good?


  A perfectly elastic good has demand that falls to zero when price changes, with PED = infinity.
• If the price of bread increases by 15% and the quantity demanded decreases by 20%, what is the PED of bread?

  The PED of bread is $-1.33$.
• How does the elasticity of demand affect the burden of an indirect tax?


  The burden of an indirect tax falls differently on consumers and firms depending on whether the good has elastic or inelastic demand.
• What happens when a firm sells a good with inelastic demand and a tax is imposed?

  The firm is likely to pass most of the tax burden onto consumers since demand will not fall significantly.
• What is the effect of a tax on a good with elastic demand?


  The firm is likely to absorb most of the tax burden to avoid losing sales due to decreased demand.
• What is the relationship between elasticity of demand and tax revenue?


  • Inelastic demand leads to higher tax revenue as consumers bear the burden.
  • Elastic demand leads to lower tax revenue as firms absorb the burden.
• What is a subsidy and its effect on supply?


  • A subsidy is a payment from the government to firms.
  • It encourages production and lowers average costs.
  • It increases supply, benefiting both producers and consumers.
• What is the formula for total revenue?

  Total revenue (TR) is calculated as TR = P x Q.
• How does inelastic demand affect total revenue when prices are raised?


  If demand is inelastic, raising prices will not significantly decrease quantity sold, thus increasing total revenue.
• What happens to total revenue if a good has elastic demand and prices are raised?


  If demand is elastic, raising prices will decrease quantity sold, thus reducing total revenue.
• What is income elasticity of demand (YED)?


  YED measures the responsiveness of demand to a change in income.
• What characterizes inferior goods in terms of income elasticity?


  Inferior goods see a fall in demand as income increases, with YED < 0.
• What defines normal goods in terms of income elasticity?


  Normal goods see an increase in demand as income increases, with YED > 0.
• What characterizes luxury goods in terms of income elasticity?


  Luxury goods see an even bigger increase in demand as income increases, with YED > 1.
• How does economic prosperity affect the production of luxury goods?


  During economic growth, firms may switch to producing more luxury goods as demand increases.
• What is cross elasticity of demand (XED)?


  XED measures the responsiveness of demand for one good to a change in the price of another good.

  
• What characterizes complementary goods in terms of XED?


  Complementary goods have a negative XED; if one good's price increases, the quantity demanded for both goods falls.
• What defines close and weak complements in terms of demand response?


  Close complements see a small price fall in good X leading to a large increase in quantity demanded of Y, while weak complements see a large price fall in good X leading to a small increase in quantity demanded of Y.
• What characterizes substitutes in terms of XED?


  Substitutes have a positive XED; if the price of one brand increases, consumers may switch to another brand.
• What defines close and weak substitutes in terms of demand response?


  Close substitutes see a small price increase in good X leading to a large increase in quantity demanded of Y, while weak substitutes see a large price increase in good X leading to a smaller increase in quantity demanded of Y.
• What characterizes unrelated goods in terms of XED?


  Unrelated goods have an XED equal to zero; the price of one good does not affect the demand for another good.
• Why are firms interested in XED?


  Firms are interested in XED to understand their competition and how price changes by others may affect their sales.
• How does the incidence of tax differ based on demand elasticity?


  If demand is more elastic (PED > 1), the tax incidence falls mainly on the supplier; if demand is more inelastic (PED < 1), it falls mainly on the consumer.
• What is the effect of a subsidy on price elasticity of demand?


  If demand is price inelastic, the subsidy will have a large effect on equilibrium price, benefiting consumers more; if demand is price elastic, it will benefit producers more.
• What is the price elasticity of supply (PES)?


  PES measures the responsiveness of a change in supply to a change in price.
• What characterizes elastic supply?

  Elastic supply allows firms to increase supply quickly at little cost, with PES > 1.
• What defines inelastic supply?

  Inelastic supply means an increase in supply will be expensive and take a long time, with PES < 1.
• What characterizes perfectly inelastic supply?

  Perfectly inelastic supply has PES = 0, meaning supply is fixed and cannot easily meet changes in demand.
• What defines perfectly elastic supply?

  Perfectly elastic supply has PES = infinity, meaning any quantity demanded can be met without changing price.
• If the price of producing wheat increased by 15% and the quantity supplied decreased by 20%, what is the PES of wheat?


  The PES of wheat is $-1.33$.
• What are the factors influencing price elasticity of demand (PED)?


  • Necessity vs. luxury goods
  • Availability of substitutes
  • Time frame (short run vs. long run)
  • Addictiveness or habitual consumption
  • Proportion of income spent on the good
  • Durability of the good
  • Peak and off-peak demand
• What are the factors affecting income elasticity of demand (YED)?


  • Nature of the good (inferior, normal, luxury)
  • Versatility of the good
  • Time for new goods to gain market attention
• What are the factors affecting cross elasticity of demand (XED)?


  • Type of good (complement, substitute, unrelated)