Flashcards in Foundations of Economic Analysis: Elasticities Deck (12)

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1

## What is Elasticity?

### Elasticity is a measure of responsiveness. It measures how much the quantity demanded or supplied varies with changes in other variables.

2

## In economics and elasticity, what are we interested in?

###
However, in economics we are also interested in the position on the line where the measurement is to take place.

The (own-) price elasticity of demand is defined as:

η = % Change in Qd / % Change in P

This measures the responsiveness of the quantity demanded to the (own-) price. η is the conventional symbol for elasticity.

3

## What is the formula that we use for elasticities?

###
The formula we use is η = ΔQ/Q ΔP/P

ΔQ = 8-4 = 4

Q = 4

Therefore the % change in Q is 100*(4/4) = 100%

ΔP = 3-5= -2

P = 5

Therefore the % change in price is 100*(-2/5) = -40%

4

## What are the five elasticity possibilities?

###
i) Perfectly inelastic, i.e. η = 0. In this case demand is unresponsive to price changes.

ii) Inelastic, i.e. 0 > η > -1. In this case quantity demanded changes by a smaller percentage than price.

iii) Unit elasticity, i.e. η = -1. In this case quantity demanded and price change by the same percentage amounts each time.

iv) Elastic, i.e. -1< η < -. In this case quantity demanded changes by a larger percentage than price.

v) Perfectly elastic, i.e. η = -. In this case quantity demanded is as much as the buyer can demand at one price and nothing at a higher price.

5

## What formula do we use to work out elasticity?

###
η = ΔQ/Q ΔP/P

(η = % Change in Qd / % Change in P)

Elasticity is not the same as the slope of the demand curve.

6

## Explain why elasticity is not the same as the slope of the demand curve?

###
Elasticity varies along the curve even though the slope is constant.

This is because of the way elasticity is calculated:

η = ΔQ/ΔP P/Q

As Q heads towards 0 then the ratio P/Q increases towards infinity, which means that the elasticity becomes infinite.

As P heads towards zero then the ratio P/Q decreases towards zero which means that the elasticity tends to 0.

7

## Give three characteristics of constant-elasticity curves?

###
Elasticity is zero: there is no change in the quantity demanded as price changes.

Elasticity is infinite - small reductions in price leads to infinite increases in demand.

Unit elasticity: the curve has elasticity 1 throughout its whole length.

8

## What is meant by cross price elasticities of demand?

###
We are focusing on (own-) price elasticities of demand in this course

However, cross-price elasticities can also be useful:

XED = (Δ% in Qd for good X)/(Δ% in Price for good Y)

If XED>0, then X and Y are substitutes (e.g. Coke and Pepsi)

If XED<0, then X and Y are complements (e.g. cars and petrol)

If XED=0, then X and Y are independent of each other

9

## What is meant by elasticity of supply?

###
Much of what has been said about the elasticity of demand can be used to describe the price elasticity of supply:

η = % Change in Qs of good X / % Change in P of good X

i.e. exactly the same as for demand except that we are looking at the responsiveness of the quantity supplied to a change in price.

10

## What is meant by the term "extreme elasticities"?

###
The "extreme" elasticities of supply are similar to those for demand.

A perfectly elastic supply curve is horizontal, while a perfectly inelastic supply curve is vertical.

One change is in unit elasticity, which is in fact a straight line graph through the origin:

11

## What is meant by income elasticity?

###
This measures the impact of changes in income on the quantity demanded of a good.

The income elasticity of demand is measured in a similar way to the other elasticities:

η = % Change in Quantity Demanded / % Change in Income

Income elasticity can be either positive or negative depending on the effect of income on the quantity demanded.

12