Elasticity Revision Summary

Transcription

1 Elasticity Revision ummary Elasticity a measure of how responsive one variable is to another rice Elasticity of emand Measures the responsiveness of demand to a change in price. E = % change in % change in % change = Change x100 Original Will always be negative as there is an inverse relationship as price increases demand decreases and vice versa. The following refers only to the numerical value, ignore the sign, although in the exam they may try and catch you out on the sign so be aware E is always negative. Numerical Value Type of E escription <1 (less than 1) A %change in price causes a smaller % change in demand. Not very responsive. =1 (equal to 1) Unitary A % change in price causes the identical % change in demand. >1 (greater than 1) Elastic A % change in price causes a larger % change in demand. Responsive. E is determined by: Availability of close substitutes Luxury or necessity How widely the market is defined roportion of a person s disposable income Time period Revenue is represented by the area of the square under the demand curve (price x quantity)

2 rice Change E Type Revenue Change Increase Elastic Increase Elastic Increase Increase or Unitary No change An elastic demand curve will be flat and an inelastic demand curve will be steep. Elastic For a perfectly elastic demand curve no matter how small the price increase the demand will always fall instantly to 0. For a perfectly inelastic demand curve any change in price no matter how large, will have any effect on demand. erfectly Elastic erfectly

3 Income Elasticity of emand Measures the responsiveness of demand to a change in income. YE = % change in % change in income Two main product classifications for YE: roduct Type Income Change Effect on emand Normal Increase Increase Inferior Increase Increase Can be positive or negative and the sign must not be ignored. roduct Type ub roduct Numerical etails Type Value Normal Luxury ositive >1 Very responsive to income change, both income and demand move in the same direction Necessity ositive <1 lightly responsive to income change Inferior Negative Income moves in the opposite direction to demand When incomes change the demand curve shifts as more or less is demanded regardless of the price of the product. The YE shows us which direction the demand curve will shift in and to what extent. For a positive value the demand curve will shift to the right (an increase in demand) and for a negative value the demand curve will shift to the left (a decrease in demand). The size of the YE value will indicate the extent of the shift.

4 Cross Elasticity of emand Measures the responsiveness of demand for one good to the price of another, related good. XE = % change in of Goodx % change in of Goody Can be positive or negative and this is very significant. Numerical Value roduct Relationship etails ositive ubstitutes The price of Goody and demand for Goodx move in the same direction. As price for one goes up people switch to the alternative and demand for this also goes up. Negative Complements The price of Goody and demand for Goodx move in opposite directions. As price of Goody goes up the demand for the good which is bought alongside it (the complement) goes down. How to remember this relationship: arty eason Nearly Christmas - ositive - ubstitute N - Negative C - Complement The strength of the relationship between the 2 products is shown by the size of the numerical value.

5 rice Elasticity of upply Measures the responsiveness of supply to a change in price. If a product/service increases in price the incentive to supply the product will increase as the firm can make a larger profit on selling it. The question is how easily can supply be increased? E = % change in % change in Always positive as both values always move in the same direction. E Type Numerical Value etails Elastic >1 upply is very responsive erfectly Elastic =infinity The % change in has no limit Unitary =1 upply changes by the same % as price <1 upply is not very responsive erfectly =0 The % change in is always 0 Elastic erfectly Elastic erfectly

6 E is determined by: ARE CAACITY How much spare capacity a firm has - if there is plenty of spare capacity, the firm should be able to increase output quite quickly without a rise in costs and therefore supply will be elastic. TOCK The level of stocks or inventories - if stocks of raw materials, components and finished products are high then the firm is able to respond to a change in demand quickly by supplying these stocks onto the market - supply will be elastic. EAE OF FACTOR UBTITUTION Consider the sudden and dramatic increase in demand for petrol canisters during the recent fuel shortage. Could manufacturers of cool-boxes or producers of other types of canister have switched their production processes quickly and easily to meet the high demand for fuel containers? If capital and labour resources are occupationally mobile then the elasticity of supply for a product is likely to be higher than if capital equipment and labour cannot easily be switched and the production process is fairly inflexible in response to changes in the pattern of demand for goods and services. TIME ERIO upply is likely to be more elastic, the longer the time period a firm has to adjust its production. In the short run, the firm may not be able to change its factor inputs. In some agricultural industries the supply is fixed and determined by planting decisions made months before, and climatic conditions, which affect the production, yield.