Terms in this set (41)
measure of responsiveness to changes in prices or incomes
how does law and demand apply with price and quantity
law of demand says that demand curves are downward sloping. so price and quantity demanded always move in opposite directions
price elasticity of demand
measures the responsiveness of the quantity demanded to changes in price
(% change in quantity demanded)/(% change in price) x100
price elasticity of demand>1
price elasticity of demand<1
when the price elasticity of demand = 1
% change in price
change in price/initial price x 100
% change in quantity demanded
change in quantity demanded/initial quantity demanded x 100
when the price elasticity of demand is large... when consumers change their quantity demanded by a large percentage compared with the percent change in the price
when quantity demanded will fall by a relatively small amount when price rises
0 price elasticity of demand, demand curve is a vertical line
horizontal demand curve, infinite price elasticity of demand. *any price increase will cause the quantity demanded to drop to 0
total value of sales of a good or service
price x quantity sold = total revenue
after a price increase, each unit sold sells at a higher price, which tends to raise revenue
after a price increase, fewer units are sold, which tends to lower revenue
what is the effect of a price increase for unit-elastic?
it doesn't change total revenue because the price effect and quantity effect exactly offset each other
4 factors that determine the price elasticity of demand
1) whether close substitutes are available
2) whether the good is a necessity or a luxury
3) share of income spent on the good
what is the effect of substitutes on the price elasticity of demand?
price elasticity of demand is high if there are other goods that consumers would be willing to consume, and low if there are no close substitutes
what is the difference in the price elasticity of demand if the good is a necessity or luxury?
PED is low if its a necessity ex: life-saving medicine
PED is high if its a luxury- something you could easily live without
how does the 'share of income' a good represents affect the price elasticity of demand?
PED is low when spending on a good accounts for a small amount of consumers' income.
PED is high when good accounts for significant share of consumers' spending- the consumer is likely to be very responsive to a change in price
how does time affect the price elasticity of demand?
PED increases as consumers have more time to adjust to a price change
long run PED often higher than short-run elasticity
Ex: significant gasoline price raise in 1980s
cross-price elasticity of demand
(between 2 goods) measures the effect of the changes in 1 goods price on the quantity demanded of the other good.
%change in quantity of A demanded / %change in price of B
how is cross-price elasticity measured?
it's size is a measure of how closely substitutable the two goods are
what happens to the price elasticity of demand when two goods are substitutes?
Ex: hot dogs and hamburgers
a rise in the price of hot dogs increases the demand for hamburgers. if close substitutes, positive and large. if not close, positive and small
what happens to the price elasticity of demand when two goods are complements?
when two goods are complements, the cross-price elasticity of demand is negative
- a rise in the price of hot dogs decreases the demand for hot dog buns
what does the size of the cross-price tell us?
the size of the cross-price between two complements tells us how strongly complementary they are:
slightly below 0=weak complements
very negative=strong complements
what does the sign of a cross-price tell us?
the sign tells us whether two goods are complements or substitutes
income elasticity of demand
measure of how much the demand for a good is affected by changes in consumers' income
=(% change in quantity demanded)/(% change in income)
what does the sign of the income elasticity of demand tell us?
if it's positive- the good is a normal good- the quantity demanded at any given price increases as income increases
if its negative- the good is an inferior good- the quantity demanded at any given price decreases as income increases
when income rises, demand for income-elastic goods rises faster than income
the income elasticity of demand for that good>1
when income rises, the demand for income-inelastic goods rises, but more slowly than income
the IED for that good is positive, but <1
which types of goods tend to be income-elastic?
which types of goods tend to be income-inelastic?
necessities such as food and clothing
price elasticity of supply
a measure of the responsiveness of the quantity of a good supplied to the price of that good
=% change in quantity supplied/% change in price
what is the difference between price elasticity of demand and price elasticity of supply?
the only difference between the two is we consider movement along the supply curve rather than along the demand curve
perfectly inelastic supply
the price elasticity of supply is zero-changes in price of the good have no effect on the quantity supplied... vertical line
perfectly elastic supply
even a tiny increase or reduction in the price will lead to very large changes in the quantity supplied. the PES is infinite- horizontal line
what factors determine the price elasticity of supply?
1) the availabilit of inputs
how does the availability of inputs effect the price elasticity of supply?
the PES is small when inputs are difficult to obtain, can be shifted into and out of production only at relatively high cost. ex: cell phone frequencies
the PES is large when inputs are readily available and can be shifted into and out of production at a relatively low cost
what effect does time have on price elasticity of supply?
PES grows larger as producers have more time to respond to price change-->long-run PES is often higher than short-run elasticity