2.6 Elasticity

• YED:

  YED > 1 : Luxury Good ( elastic )

  YED < 1 : Normal good ( inelastic )

  YED = 0 : No relationship

  YED > -1 : Inferior good (Inelastic)

  YED < -1 : Inferior good (elastic)
• XED:

  XED = positive (substitute good)

  XED = negative (complementary good)

  XED = 0 (unrelated products)
• XED:

  XED= % change Quantity demanded of A/ % change price of B
• PES:

  0 : perfectly inelastic

  0 to 1 : Inelastic

  1 : Unit elastic

  1 to infinity : Elastic

  infinity : Perfectly elastic
• PES:

  PES= % change in quantity supplied/ % change in price

  PES is always positive
• YED:

  YED = % change in quantity demanded/ % change in income
• Elasticity

  How responsive demand or supply is to a change in price.
• Cross elasticity of demand (XED)

  The responsiveness of demand of one good (A) to a change in price of another good (B), calculated by: %change in QD of A divided by %change in P of B
• Complementary goods

  Negative XED; if good B becomes more expensive, demand for good A falls.
• Substitutes

  Positive XED; good B becomes more expensive, demand for good A increases
• Unrelated goods

  XED=0; if the price of good B changes, it has no impact on the demand for good A
• Income elasticity of demand(YED)

  The responsiveness of demand to a change in income calculated by %change in QD divided by %change in Income
• Inferior goods

  YED<0; goods which see a fall in demand as income increases.
• Luxury goods

  YED>1; an increase in income causes an even bigger increase
• Normal goods

  YED>0; demand increases as income increases.
• Perfectly price elastic good

  PED/PES=Infinity, quantity demanded/supplied falls to zero when price changes.
• Perfectly price inelastic good

  PED/PES=0; quantity demanded/supplied does not change when price changes
• Price elastic good

  When PED/PES>1; demand/supply is relatively responsive so a small change in price leads to a large change in quantity demanded/supplied.
• Price elasticity of demand

  The responsiveness of demand to a change in price. calculated by: %change in QD divided by %change in P.
• Elastic PED


  PED > 1. An increase in price causes a decrease in total revenue. A decrease in price causes an increase in total revenue.
• Inelastic PED

  PED < 1. An increase in price causes an increase total revenue. A decrease in price causes a decrease in total revenue.
• Price elasticity of supply

  The responsiveness of supply to a change in price, calculated by: %change in QS divided by %change in P.
• Perfectly inelastic PES

  When price changes, the quantity supplied does not change at all. Quantity supplied is totally unresponsive to a change in price.
• Inelastic PES

  0 to 1. When price changes, the quantity supplied changes by a smaller percentage. Quantity supplied is relatively unresponsive to a change in price.
• Elastic PES

  1 to ∞. When price changes, the quantity supplied changes by a larger percentage. Quantity supplied is relatively responsive to a change in price.
• Perfectly elastic PES

  ∞. When price changes, the quantity supplied changes infinitely. There can be only one price.
• Unit Elastic PES

  1. When price changes, the quantity supplied changes by the same percentage. Quantity supplied has the same response as a change in price.
• The usefulness and significance of elasticity calculations depends upon...

  1. The reliability of the data.

  2. The time period.

  3. The actions of competitors. Elasticity is calculated with the assumption of ceteris paribus.

  4. Changing fashions and trends. PED, YED, XED all depend on fashions and taste.
• Elasticity - business use

  PED:

  Pricing decision to increase total revenue .

  Employment stocks and output

  PES:

  Find ways to make supply price elastic ( PSSST )

  XED:

  Pricing decision .

  Non - price competition as a cut price leads to price wars .

  Employment stocks and output

  YED:

  Pricing decision ( plans for recessions and booms )

  employment stocks and output
• Determinants of PED ( SPLAT )


  Substitutes ( number of... )

  Percentage of Income

  Luxuries or necessities

  Addictive

  Time period : SR PED is inelastic due to fewer substitutes
• Determinants of PES ( PSSST )


  Production lag - the longer the production lag the more price inelastic it going to be

  Stocks - the larger level stock the more price elastic it is going to be

  Spare capacity - the more spare capacity the more price elastic it is going to be

  Substitutability of factors of production - the easier it is to swap when there is a change in demand the more elastic it is

  Time - Short run price is more inelastic as at least one factor of production is fixed.