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Chapter 4 – Elasticities 9/10

Elasticity of demand ~> how much the demand for a product changes when there is a
change in one of the factors that determine demand
3 types:
1) Price Elasticity of Demand(PED)
2) Cross Elasticity of Demand(XED)
3) Income Elasticity of Demand(YED)

1/ Price Elasticity of Demand – PED


Definition: The responsiveness of change in quantity demanded to a change in its price

Formula: % Δ in Quantity Demanded / % Δ in Price

PED value range


• 1 < Answer < ∞ ~> Elastic
• 0 < Answer < 1 ~> Inelastic
• Answer = 1 ~> Unitary elasticity

• Answer = ∞ ~> Perfectly elastic


• Answer = 0 ~> Perfectly inelastic

How to increase revenue


• Inelastic ~> Increase Price
• Elastic ~> Decrease Price

Factors affecting PED Nasty Snake Cuts Nine Tangerines ~> NSCNT
1) Number of Substitutes a good has and the Closeness between the substitutes
~> The more substitutes there are and the closer the substitutes = Good is more
elastic (&vice versa)
2) Weather the good is a Necessity or not
~> If the good is a necessity = inelastic (&vice versa)
3) Time period considered
~> Takes time for buying habits of consumers to change
~> Inelastic in short term but Elastic in long term
2/ Cross Elasticity of Demand – XED
Definition: The responsiveness of the change in quantity demanded for one product to a
change in price for another product. Calculates weather two goods are complements or
substitutes.

Formula: % Δ in Quantity Demanded for Product X / % Δ in Price of product Y

XED value range


• Positive ~> Substitute goods, <<+ = subs>>
• Negative ~> Complementary goods, <<– = comp>>
• Zero ~> Unrelated products
• The larger the positive value is, the closer the goods are as substitutes
• The larger the negative value is, the closer the goods are as complements

3/ Income Elasticity of Demand – YED


Definition: The responsiveness of the change in quantity demanded to a change in
consumer income.

Formula: % Δ in Quantity Demanded for a Product / % Δ in Income of a consumer

YED value range


• Positive ~> 0 < answer < 1 = essential products/necessities EG: bread
~> 1 < answer = superior products/non-essential EG: holidays
• Negative, answer < 0 = Inferior goods EG: cheap wine

Elasticity of Supply ~> how much the supply for a product changes when there is a
change in one of the factors that determine supply

Price Elasticity of Supply – PES


Definition: The responsiveness of the change in quantity supplied to a change in the
product's price.

Formula: % Δ in Quantity Supplied / % Δ in Price


PES value range
• 1 < Answer < ∞ ~> Elastic
• 0 < Answer < 1 ~> Inelastic
• Answer = 1 ~> Unitary elasticity

• Answer = ∞ ~> Perfectly elastic


• Answer = 0 ~> Perfectly inelastic

Factors affecting PES


• Time
~> The longer it takes to produce, the more inelastic a good will be.
• How much total cost of production rises as output rises
~> If producing more causes total cost of production to rise by a large amount, the
good will remain inelastic.
~> Too expensive to start producing immediately for company won't be able to
cover its rising costs.
• The more(and easily) stocks that can be stored, the more elastic the good is.
~> When the price changes, the stored stock of goods can just be released instead
of producing more.
• Manufactured goods are elastic. Agricultural goods are inelastic.
~> Manufactured goods take shorter time to produce while agricultural goods take
longer time to produce.

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