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115.030.10.02 Economics - Reading 12 - 2. Elasticities of Demand

2. Elasticities of Demand

a. calculate and interpret price, income, and cross-price elasticities of demand and describe factors that affect each measure;

What is the first law of demand?
Price and quantity demanded move in opposite directions.

What is elasticity of demand?
Elasticity of demand measures the responsiveness of the quantity demanded of a product to changes in any of the factors that affect demand.

What is price elasticity of demand? What is the math notation for it?
- The percentage of change in the quantity of a product demanded divided by the percent change in the price causing the change in quantity. It indicates the degree of consumer response to variation in price.
- $$E_p^d = \frac{\% \Delta Q_x^d}{\% \Delta P_x}$$

If the elasticity coefficient is greater than 1, is the demand elastic or inelastic? What does it mean?
An elasticity coefficient > 1 means demand is elastic, and a small price change leads to a large change in the quantity demanded. Demands for goods with many substitutes (e.g., juice) are relatively elastic.

What is a "perfectly elastic" demand?
When demand is perfectly elastic, consumers will buy all of the good at whatever the market price.

If the elasticity coefficient is less than 1, is the demand elastic or inelastic? What does it mean?
An elasticity coefficient < 1 means the demand is inelastic. The more inelastic the demand, the steeper the demand curve. Demands for goods with few substitutes (e.g., cigarettes) are relatively inelastic.

What is it called when the elasticity coefficient = 1?
Unitary elastic

When demand is inelastic, a change in price will cause _??____
...total expenditures to change in the same direction.

When demand is elastic, a change in price will cause _??____
...total expenditures to move in the opposite direction.

When demand elasticity is unitary, total expenditures will _??____
...remain unchanged as price changes.

What are the three factors that influence supply and demand?
1. The closeness of substitutes
2. The proportion of income spent on the good
3. The time elapsed since a price change

What is the second law of demand?
The price elasticity of demand tends to increase in the long run. In general, when the price of a product increases, consumers will reduce their consumption by a larger amount in the long run than in the short run. Thus, the demand for most products will be more elastic in the long run than in the short run. This relationship between the elasticity coefficient and the length of the adjustment period is referred to as the second law of demand.

Total Revenues = Total (Consumer) Expenditures = ??
Price * Quantity

What is Income Elasticity of Demand for Normal and Inferior Goods? What is the math formula for it?
- The percentage change in the quantity of a product demanded divided by the percentage change in consumer income causing the change in quantity demanded.
- Since increases in consumer income will increase the demand for most goods, income elasticity measures the responsiveness of a demand for a good to a change in income. Specifically, it tells the analyst the percentage change in the quantity demanded for a good caused by a 1% increase in consumer income.
- $$E_I^d = \frac{\% \Delta Q_x^d}{\% \Delta I}$$

How do "normal goods", i.e. everyday necessities and luxury goods, elasticity change when consumer income increases?
Both necessities and luxury goods have positive income elasticity. People purchase more when their income goes up. They purchase a little bit more necessities, and far more luxuries.

What are normal goods? What are inferior goods?
- Normal goods are everyday necessities and luxury goods
- Inferior goods are commodities. As consumer income rises, demand falls.

What is cross-price elasticity of demand? What is the math formula?
- The cross elasticity of demand is a measure of the responsiveness of demand for a good to a change in the price of a substitute or a complement, other factors remaining the same.
- $$E_{P_y}^d = \frac{\% \Delta Q_x^d}{\% \Delta P_y}$$

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