2.6: Elasticity

• Elasticity


  A measure of the sensitivity of one variable to a change in another variable
• PED


  Measure of the sensitivity of quantity demanded to a change in price
• PED calculation


  % change in quantity demanded / % change in price
• YED


  Measure of the sensitivity of quantity demanded to a change in income
• YED calculation


  % change in quantity demanded / % change in income
• XED


  Measure of the sensitivity of quantity demanded of one good to a change in price of another good
• XED calculation


  % change in quantity demanded for good A / % change in price of good B
• PES


  Measure of the sensitivity of quantity supplied to a change in price
• PES calculation


  % change in quantity supplied / % change in price
• PED = infinity


  - Perfectly elastic

  - % change in quantity demanded is infinite
• PED > 1


  - Relatively elastic

  - % change in quantity demanded is greater than the % change in price
• PED = 1


  - Unit elastic

  - % change in quantity demanded is equal to the % change in price
• PED < 1


  - Relatively inelastic

  - % change in quantity demanded is less than the % change in price
• PED = 0


  - Perfectly inelastic

  - No change in quantity demanded when price changes
• YED < -1


  Elastic inferior good
• -1 < YED < 0


  Inelastic inferior good
• YED = 0


  No relationship between income and quantity demanded
• 0 < YED < 1

  Inelastic normal good
• YED > 1


  - Elastic normal good

  - Also known as a superior good
• XED < -1


  Strong complements
• -1 < XED < 0


  Weak complements
• XED = 0


  No relationship between the two goods
• 0 < XED < 1


  Weak substitutes
• XED > 1


  Strong substitutes
• PES = 0


  - Perfectly inelastic

  - No response to a change in price from supply
• 0 < PES < 1

  - Relatively inelastic

  - Less than proportionate response in supply to a change in price
• PES = 1


  - Unit elastic

  - % change in quantity supplied is equal to the percentage change in price
• 1 < PES < infinity

  - Relatively elastic

  - More than proportionate response in supply to a change in price
• PES = infinity


  - Perfectly elastic

  - If producers are prepared to supply any amount at a given price
• Impact of a lower price on total revenue

  Total revenue will rise as long as demand is relatively price elastic
• Impact of a higher price on total revenue

  Total revenue will rise as long as demand is relatively price inelastic
• Impact of the PED of a good being unit elastic on total revenue


  Total revenue will be at its highest
• Determinants of PED


  - Substitutes

  - Price

  - Luxuries

  - Addictiveness

  - Time
• Determinants of YED


  - Change in household income

  - Increase = rise in demand for normal/superior goods

  - Decrease = rise in demand for inferior goods
• Determinants of PES


  - Capacity

  - Availability of substitutes

  - Time

  - Stock of goods

  - Barriers to entry
• Usefulness and significance of PED

  - Just an estimate and may change over time

  - Markets change

  - Customers become more or less sensitive to price changes

  - Management needs to be aware of the factors that influence demand and act accordingly
• Usefulness and significance of YED

  - Indicates effect of changes in consumer income on demand

  - In normal times, producers of normal goods and superior goods benefit because they are operating in an expanding market

  - During a recession, producers or normal goods will experience a fall in demand and producers of inferior goods will experience a rise in demand
• Usefulness and significance of XED

  - + or - tells us about the relationship between the two goods (+ meaning they are substitutes and - meaning they are complements)

  - Numerical value indicates closeness of the relationship (high values meaning a stronger relationship)
• Usefulness and significance of PES

  + means there is a positive relationship between price and quantity supplied