1.2 Elasticity

Substitutability

-Coca cola and Pepsi have greater substitutability than Coca-cola and orange juice because they're closer. -A factor that affects the number of substitutes is whether it's defined narrowly or broadly. The more narrowly defined the good, the more close substitutes they are. e.g demand for apples is more elastic than the demand for fruit because they're more substitutes.

Giffen good

A good that is so strong that people consume more of as the price rises and vice versa. The conditions are that it must be an inferior good, make up a large proportion of their income and have little substitutes. This results in the income effect being larger than the substitution effect. e.g. inferior quality staple foods and as the price of the cheap staple rises, they can no longer afford to supplement their diet with better foods, and must consume more of the staple food.

Veblen good

A type of luxury good where as the price of a good rises, people with high incomes buy more of the product. This is because there is the 'snob effect' where the good is a status symbol because of how it's usually a positional good. Also, Veblen described the phenomena of conspicuous consumption and conspicuous leisure for the wealthy. e.g. champagne

How PED varies along the demand curve

On any downward sloping, straight demand curve, demand is price-elastic at low quantities and high prices and price-inelastic at high quantities and low prices. The midpoint is unit elastic demand. Therefore, for most demand curves, only the parts should be referred to as with one of the above.

PED=0

Perfectly inelastic demand. Quantity demanded is completely unresponsive to price. e.g heroin for heroin addicts

Primary commodities

Products from agriculture, fishing and the extractive industries etc

When PES>1

Supply is price elastic. The percentage change in quantity supplied is greater than the percentage change in price. The supply curve extends upwards and to the right from the vertical axis. It cuts the vertical axis so it has a negative Q-intercept. The flatter the supply curve, the more elastic it is at any given price.

When XED=0

The goods are completely independent of each other.

Why PED varies along the demand curve

This is because at high prices and low quantities, the percentage change in quantity demanded is large while there is a small change in price. Therefore, big %QD change/small %P change means PED is high.

1<PED<∞

This is elastic demand which means the percentage change in quantity demanded is larger than the percentage change in price.

The gradient of a demand curve

∆Q/∆P It's different from the PED because that is the percentage change.

How the gradient of a demand curve relates to the PED

∆∆∆∆∆∆∆

Determinants of PES

-Amount of time firms have to adjust their inputs. In the short run, as in the diagram supply is perfectly inelastic since there is only so much inventory they have. As the length of time increase, firms become more responsive and PES increases. e.g more labour can be hired and eventually more machines bought. -Mobility of FoP so how quickly firms can shift their resources and production between different products. -Unused capacity. The greater the spare capacity, the more elastic the supply. -Ability to store stocks. If firms can store stocks, the higher PES for their products than firms who cannot store stocks. This only affects PES for short periods because once the stocks are the sold, the other determinants are more important

Implications of XED for businesses

-Businesses with a line of similar products need to know the XED and the substitutability for their products in relation with each other. -Substitutes produced by rival businesses. A large XED would mean a small change in price of one good, would significantly decrease the demand for the other good. -Businesses who merge with close substitute products would be interested in the XED because they could eliminate the competition (illegal). -Businesses collaborating with complementary goods. Also, the impact of indirect taxes on the other good. e.g lowering the price flights, significantly increases the demand for holiday hotels.

Determinants of PED

-Number and closeness of substitutes. The more substitutes and the closer they are, the more elastic the good is. e.g toothpaste brands are elastic but petrol (as a whole) is inelastic. -Degree of necessity. Necessity vs luxury -Time. The longer the time a consumer has to decide, the more elastic the good because they can think if they really need it and look for alternatives. e.g Demand for heating oil over short periods is inelastic but over time elastic. -Proportion of income spent on the good. The larger the proportion, the more elastic the good.

When can PEDs be compared using the steepness of the line

-Only when they intersect at a point so they share a price and quantity combination. This only works for specific prices. The PED of D_2 is more inelastic than D_1 at every price point because it's steeper. -The parallel demand curves don't share a price-quantity combination and have different PEDs. For every price, D_2 is less elastic than D_1 because where PED=1 for D_1, at the same price PED<1 for D_2

Debate around the externalities of positional goods

-There is a problem of over-supply because all agents may try to consume positive amounts of these goods, neglecting to consider the externalities on others. The government can impose a luxury tax to correct for the externality and social waste from the positional goods 'arms race'. -However, in some cases the luxury tax impedes improvements in living standards and innovation. This is because the technological advance is partly possible because wealthy individuals are willing to be first purchasers of new and untested goods. If they're found to be useful they may be mass-produced and made affordable to the common person. Therefore, the negative positional externality can be compensated by the public goods of infant industry effects and R&D. e.g mobile phones in the 1990s

Effect of PED on total revenue

-When PED>1, a decrease in price, increases the total revenue. If increased, then area B is lost and the smaller C is gained so TR decreases. -When PED=1, a change in price doesn't change TR. This is the maximum total revenue possible from changing the price. -When PED>1, an increase in price, increases TR. Area C is greater than the area of B.

How does PES vary along supply curves

Along any upward sloping, straight supply curve PES varies. However, a constant PES is found in unit elastic, perfectly elastic and perfectly inelastic supply curves.

Income elasticity of demand (YED)

A measure of the responsiveness of demand to changes in income. This involves a shift in the demand curve.

YED (Income Elasticity of Demand)

A measure of the responsiveness of demand to changes in income. This involves shifts in the demand curve.

Cross-price elasticity of demand (XED)

A measure of the responsiveness of the demand for one good to a change in the price of another good. This involves a shift in the demand curve.

Price elasticity of demand (PED)

A measure of the responsiveness of the quantity demanded of a good to changes in its price along a given demand curve.

Price elasticity of supply

A measure of the responsiveness of the quantity of a good supplied to changes in its price along a given supply curve.

Manufactured goods

A product that has been processed with machinery

Impact of YED on the rate of expansion.

As countries experience economic growth, society's income increases and the demand for goods with a YED above 1 (income elastic demand), usually in the services sector (restaurants, films), will grow at a higher rate than the agricultural sector with YED<1. Over time the share of agricultural output in the total output decreases, while share of the manufacturing and services sector increases. Eventually, in developed economies, the services sector dominates the share of the total output. Equally, in a recession, goods with high YEDs will experience the largest decline in their sales.

Why positional goods are a zero sum game and can mean a person does worse than their grandparents

As economic growth improves overall quality of life at any particular level, doing "better" than how an individual's grandparents lived does not translate automatically into doing "well". This is because there might be more people ahead of them in the economic hierarchy. e.g. if someone is the first in their family to get a college degree, they are doing better but if they were at the bottom of their class at a weak school, they may find themselves less eligible for a job than their grandfather, who was only a high school graduate. Therefore, competition for positional goods is a zero-sum game because attempts to acquire them can only benefit one player at the expense of others.

Implications of XED for a business with a line of products

For a business with a line of products (Coca-Cola and Sprite), PED can be determined but then the XED needs to be determined if the increased total revenue from a price change in one good would be offset with decreased TR from another good.

Positional goods

Goods that are valued only by how they are distributed among the population, not by how many of them there are available in total as would be the case with other consumer goods. The source of greater worth of positional goods is their desirability as a status symbol, which usually results in them greatly exceeding the value of comparable goods. . e.g university degree, olympic medals

Consequences of low PED for primary commodities

Low PED and fluctuations in supply over short time periods create serious problems for producers because it results in high price volatility. The diagram shows how there are larger fluctuations in price when the good is inelastic.

Why the PED for many primary commodities is relatively low and PED for manufactured goods is relatively high

Primary commodities such as wheat have a lower PED than manufactured goods because they're necessities and have no substitutes. While manufactured goods can be necessities, they usually have many substitutes (except medicine).

Consequences for low PES for primary commodities

The price inelastic supply of primary commodities contributes to price and income instability for producers. The diagram shows how with an inelastic supply curve, when demand changes, there are larger price changes. This means unstable revenue for producers.

When PES<1

Supply is price inelastic. The percentage change in quantity supplied is smaller than the percentage change in price. The supply curve extends upward to the right from the horizontal axis. It cuts the horizontal axis so it has a positive Q-intercept. The steeper the supply curve, the more inelastic it is at any given price.

Total revenue

The amount of money received by firms when they sell a good or service. TR = P x Q.

The impact of PED on indirect taxes

The government must consider the PED because the lower the price elasticity of demand for the taxed good, the greater the government tax revenues. This is why indirect taxes are usually imposed on goods like cigarettes and petrol with low PED.

Why do primary commodities have a low PES compared to manufactured products

This is because for primary commodities a long time is needed for the quantity supplied to respond to price changes. e.g. in agriculture farmers need at least a planting season to respond to price changes and there is a limited amount of new land that can be bought (could even be shrinking due to environmental degradation). The only way is to increase crop yields by technological change such as new seeds that take a long time.

0<PED<1

This is inelastic demand, which means the percentage change in quantity demanded is less than the percentage change in price. Illustrated as a steep line, although it depends on the scale used and what part of the demand curve is compared.

PED= ∞

This is perfectly elastic demand. Quantity demanded is infinitely responsive to price. Occurs in a perfectly competitive market.

When PES=∞

This is perfectly inelastic supply. The percentage change in quantity supplied is infinite when there is a percentage change in price.

When PES=0

This is perfectly inelastic supply. There is no change in quantity supplied, no matter how the price changes. e.g. the supply of fish at the exact moment when fishing boats return from the sea

PED=1

This is unit elastic demand. Percentage change in quantity demanded equals percentage change in price

When 1<YED<∞

This means it's a luxury good so it has income elastic demand. A percentage increase in income, produces a larger percentage increase in quantity demanded. e.g restaurants, films at the cinema

When 0<YED<1

This means it's a necessity, so it has income inelastic demand. As a result, a percentage increase in income, produces a smaller percentage increase in quantity demanded. e.g food, regular furniture, regular clothing

When YED is negative

This means it's an inferior good so demand and income change in opposite directions (income increases and demand decreases). e.g bus tickets, second hand clothes

When YED is positive

This means its a normal good so demand and income change in the same direction (both increase or both decrease).

Negative XED

This means the two goods are complements. When the price of good X increases so its quantity demanded decreases, the demand for good Y decreases. (demand and price change in opposite directions) The larger the value from 0, the larger the complementarity of the goods and the larger the shift in demand from a price change. e.g tennis balls and tennis rackets

Positive XED

This means the two goods are substitutes. When the price of good X increases so its quantity demanded decreases, the demand for good Y increases. The larger the value, the greater the substitutability of the goods, and the larger the demand curve shift when the price for one changes. e.g Pepsi and Coca-Cola

When PES=1

Unit elastic supply. The percentage change in supply is equal to the percentage change in price. Any supply curve that passes through the origin has unit elastic supply. This is because the steepness of the line doesn't affect the elasticity but the difference between any two points on the vertical axis is the same as the horizontal axis.

PED formula

percentage change in quantity demanded /percentage change in price When PED varies because of the choice of the initial price-quantity combination, a midpoint of the initial price point and quantity can be used. Since there is a negative causal relationship between price and quantity demanded, the value is always negative but is treated as positive (taking the absolute value)

XED formula

∆% in QD of good X / ∆% in price of good Y The sign of the XED shows whether demand increases or decreased and the absolute value shows how closely related the goods are, so the size of the shift. The sign is important.

YED formula

∆% in QD/∆% in income. The sign shows the direction of the shift in the demand curve and the values shows the size of the demand curve shift.

PES formula

∆% in quantity supplied/∆% in price Since there is a positive relationship, PES is always positive.