Elasticity Definitions and Formulas:
– Price Elasticity of Demand (PED) measures how sensitive a change in quantity demanded (Qd) is, in response to a price change (P)
PED = %∆Qd / %∆P = Percentage Change in Quantity Demanded / Percentage Change in Price
– Income Elasticity of Demand (YED) measures how sensitive a change in quantity demanded (Qd) is, as a response to a change in household incomes (Y)
YED = %∆Qd / %∆Y = Percentage Change in Quantity Demanded / Percentage Change in Income
– Cross Elasticity of Demand (XED) measures how sensitive a change in quantity demanded (Qa) for Good A is, as a response to a change in price for Good B (Pb)
YED = %∆Qa / %∆Pb = Percentage Change in Quantity Demanded for Good A / Percentage Change in Price for Good B
– Price Elasticity of Supply (PES) measures how sensitive a change in quantity supplied (Qs) is, as a response to a change in price (P)
PED = %∆Qd / %∆P = Percentage Change in Quantity Supplied / Percentage Change in Price
Elasticity Notes with Calculations
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Elasticity Notes Explanation & Examples:
– PED measures how much more of the good would people buy if there is a price reduction, vice versa. If prices for plush teddies fall by 10%, but quantity demanded rises by 20%, then the PED is +20%/-10% = -2. This means a small decrease in price lead to a much larger quantity purchased, and the good has elastic PED. A PED of <1 is inelastic and >1 is elastic (note PED is always negative, but we ignore the minus sign). Necessities tend to have inelastic PED as you buy a similar amount despite price changes – see Elasticity and Oil Prices.
– YED measures whether we will buy more or less of a certain good if we get richer. You would most likely buy less canned food like SPAM or corned beef if you win the lottery (which people have been hoarding), as you will be eating at Michelin starred restaurants. If a 10% increase in income leads to a 20% fall in quantity demanded for SPAM, YED is -20%/+10% = -2, meaning it is an inferior good, making YED negative. Vice versa for luxury goods.
– XED is used to assess the relationship between two goods. If they are substitutes of one another (e.g. fidget spinners and fidget cubes), they will have positive XED. This is because a rise in the price of fidget spinners cause people to buy less fidget spinners (due to the price hike) and buy more fidget cubes. This makes both the percentage change in Qa and Pb positive, vice versa.
– PES is used to assess how responsive producers in a market are to price changes. In general, producers produce more when market prices are high – more masks are produced in an epidemic as people pay a high price for it. If mask prices increase by 100% but quantity supplied only increases by 10%, PES is +10%/+100% = 0.1 meaning mask producers are unable to increase quantity of masks supplied in the market, and PES is inelastic.
Elasticity Multiple Choice Questions (A-Level)
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