PPT 6

• Substitutability 


  the larger the number of substitute goods that are available, the greater the price elasticity of a demand
• Proportion of Income


  other things equal, the greater proportion of income spent on a good, the greater the elasticity of a demand for it.
• Luxuries versus necessities


  the more that a good is considered luxury, the greater is the price elasticity
• Time


  product demand is more elastic the longer the period under consideration. Studies shows that short-run demand for gasoline is more inelastic than in the long-run demand
• Incidence evenly split


  Incidence shared evenly between consumer and producer
• Incidence more on the consumer

  Incidence more on the consumer when demand is more price inelastic
• Incidence more on the producer

  Incidence more on the producer when demand is more price elastic.
• Inferior Goods

  • Cabbage
  • long distance bus tickets
  • used clothing
  • retread tires
• Consumer surplus and price are inversely (negative related). Given the demand curve, higher prices reduce consumers surplus lower prices increase it.
• Price Elasticity of Demand


  A measure of the responsiveness of buyers to a change in the price of a product or resource
• Elastic demand


  Product demand whose price elasticity or coefficient is greater than one
• Inelastic demand


  Product or resource demand for which the priced elasticity coefficient is less than 1
• There is a direct (positive) relationship between equilibrium price and the amount of producer surplus. Given the supply curve, lower prices reduce producer surplus, higher prices increase it.
• Unit elastic


  Demand or supply for which the elasticity coefficient are the same or equal to 1
• Total revenue


  The total number of dollars(pesos) receive by a firm from the sale of product in a particular period
• Total Revenue Test


  A test to determine the elasticity of demand between two prices
• Total Revenue Test


  • Figure A: Demand is elastic, gain in revenue exceeds loss

  Figure B: Demand is inelastic, gain in revenue less than loss

  Figure C: Demand is unit elastic, gain equals loss
• Summary of Price Elasticity of Demand

  • Elastic or relatively elastic (Ed > 1): Quantity demanded changes by a larger percentage than price, Total revenue decreases with price increase, Total revenue increases with price decrease

  Unit or unitary elastic (Ed = 1): Quantity demanded changes by the same percentage with price, Total revenue is unchanged

  Inelastic or relatively inelastic (Ed < 1): Quantity demanded changes by a smaller percentage than price, Total revenue increases with price increase, Total revenue decreases with price decrease
• Determinants of Price Elasticity of Demand

  • Substitutability

  Proportion of income

  Luxuries versus necessities

  Time
• Price Elasticity of Supply


  Percentage change in quantity supplied of a product or resource to the percentage change in its price
• Market Period


  A period in which producers of a product are unable to change the quantity produced in response to a change in its price
• Short run


  A period of time in which producers are able to change the quantities of some but not all of the resources they employ
• Long run


  A period of time long enough to enable the producers of a product to change the quantities of all of the resources they employ
• Cross Elasticity of Demand


  The ratio of the percentage change in quantity demanded of one good to the percentage change in the price of some other good
• Substitute Goods


  If cross elasticity is positive, meaning that the sale of X move the same direction as a change in the price of Y, then X and Y are substitute goods
• Complementary Goods


  When cross elasticity is negative, we know that X and Y "go together", an increase in the price of one decreases the demand for the other. They are complementary goods.
• Independent Goods


  A zero or near zero elasticity tell us that the two products being considered are unrelated or independent goods
• Income Elasticity of Demand


  Measures the responsiveness of consumer purchases to income changes
• Normal goods


  The income elasticity coefficient is positive, meaning that more of them, are demand as income rise
• Inferior goods


  A negative income elasticity coefficient designates an inferior good. Consumers decrease their purchases of inferior goods an income rises.
• Incidence of tax


  Refers to the extent to which an individual or organization suffers from the imposition of a tax – it may fall on the consumer, the producer, or both. The incidence is also called the 'burden' of taxation.
• How the incidence of tax falls depends upon the price elasticity of demand and supply
• Complements


  Positive (Ei > 0) - Quantity demanded of the product changes in same direction as change in income
• Normal


  Negative (Ei < 0) - Quantity demanded of the product changes in opposite direction as change in income
• Inferior


  Negative (Ei < 0) - Quantity demanded of the product changes in opposite direction as change in income
• Cross Elasticity


  Measures how responsive the quantity demanded of one good is to a change in the price of another good
• Income Elasticity


  Measures how responsive the quantity demanded of a good is to a change in consumer income
• Incidence of tax


  Refers to the extent to which an individual or organisation suffers from the imposition of a tax – it may fall on the consumer, the producer, or both
• If demand is inelastic

  Price to the buyer will increase substantially and most of the tax will be shifted to consumers
• If demand is elastic

  Price rises modestly when the tax is levied, so the producer bears most of the tax burden