elasticity

• Elasticity


  How responsive demand or supply is to a change in price

  
• Price elasticity of demand (PED)


  The responsiveness of a change in demand to a change in price

  
• Price elastic good


  • Very responsive to a change in price, PED > 1
• Price inelastic good


  • Relatively unresponsive to a change in price, PED < 1
• Unitary elastic good


  • Change in demand equal to change in price, PED = 1

  
• Perfectly inelastic good


  • Demand does not change when price changes, PED = 0
• Perfectly elastic good


  • Demand falls to zero when price changes, PED = infinity
• Elasticity of demand and tax revenue

  The burden of an indirect tax will fall differently on consumers and firms, depending on if the good has an elastic or inelastic demand
• Inelastic demand


  Firm can put most of the tax burden on the consumer as demand will not fall significantly
• Elastic demand


  Firm will take most of the tax burden as they know demand will fall significantly
• Elasticity of demand and subsidies

  A subsidy increases supply, the benefit can go to producer or consumer depending on PED
• PED and total revenue

  Inelastic demand allows firm to raise price and increase total revenue, elastic demand will reduce total revenue

  
• Income elasticity of demand (YED)

  The responsiveness of a change in demand to a change in income
• Inferior goods


  • Demand falls as income increases, YED < 0

  
• Normal goods


  • Demand increases as income increases, YED > 0
• Luxury goods


  • Demand increases more than proportionately to income increase, YED > 1
• During prosperity, firms may switch to producing more luxury goods
• Cross elasticity of demand (XED)

  The responsiveness of a change in demand of one good to a change in price of another good

  
• Complementary goods


  • Have a negative XED, demand for both falls if price of one increases
• Substitute goods


  • Have a positive XED, demand for one increases if price of other increases
• Unrelated goods


  • Have an XED of zero, price change of one has no effect on demand for the other
• Firms interested in XED to see how many competitors they have
• Inelastic demand tax burden

  Tax burden falls mainly on consumer
• Elastic demand tax burden


  Tax burden falls mainly on supplier
• Inelastic demand subsidy 


  Subsidy has large effect on price, benefits consumers more
• Elastic demand subsidy 


  Subsidy has large effect on quantity, benefits producers more
• Price elasticity of supply (PES)


  The responsiveness of a change in supply to a change in price

  
• Elastic supply


  • Firms can increase supply quickly at little cost, PES > 1
• Inelastic supply


  • Increasing supply is expensive for firms and takes time, PES < 1
• Perfectly inelastic supply


  • Supply is fixed, PES = 0
• Perfectly elastic supply


  • Any quantity can be met without changing price, PES = infinity
• if a firm sells an inelastic good they are more likely to put most tax burden on the consumer because they know price increase won't make demand fall significantly
• if a firm makes a good with elastic demand they are most likely to take on the tax burden themselves because they know if the price increases demand is likely to fall and Lowe their revenue
• inelastic good are more effective at raising government revenue
• Factors influencing PED


  • Necessity
  • Substitutes
  • Proportion of income spent
  • Durability
  • Addictiveness
• factors effecting YED

  • versatility (multiple uses)
  • nature of the good
• factors effecting XED

  • the type of good
• factors effecting PES

  • time scale- short run inelastic
  • spare capacity-resources in the eceonomy
  • level of stock( time that is can be held in stock)