Determinants of PES:

(QA2 QA1 ) QA1 (QS 2 QS1 ) QS1 Time following change in price
XED = PES =
Implications for businesses/government (PB2 PB1 ) PB1 (P2 P1 ) P1 -Market period (S1)- no time to adjust output - highly inelastic
-firms considering raise/lower prices -Short run (S2)- can make changes - more elastic
-effect that changes in the prices of other goods will XED = quantity vs. price of related good PES = supply vs. price -Long run (S3) - factors of production are variable - highly elastic
have on market demand for them -negative - complements -More responsive over time
-deciding taxes on goods or raise/lower income tax -positive ± substitutes Mobility of the factors of production
-goods - little tax revenue, decrease in sold -size - indication of how closely related two -Relatively elastic: manufactured & low skilled - easily hire
-income - reduce overall spending may be goods are. Higher = closer more/less workers
useless if demand is unresponsive to changes in -extremely unrelated = neither complements -Relative inelastic: heavy industrials & primary commodities -
disposable income. or substitutes.   changes are costly & time consuming.
Elastic - small increase in price -> large decrease The ability to store stocks
in demand = price sensitive - responsive -Large inventories - control supply - highly responsive - elastic
 Inelastic -large increases in price -> little decrease -Perishable goods - cannot control - unresponsive - inelastic.
in demand = price insensitive - unreponsive The amount of unused capacity
D2(Q  
D1 Q ) QD1 -Large amounts of excess capacity - elastic
PED = PED ± Demand vs. Price -Already at full capacity - inelastic  
(P2 P1 ) P1
PED < 1: inelastic demand Excise taxes and PES
-¨LQTXDQWLW\ZDVOHVVWKDQ¨LQSULFH -Excise tax - paid by both producers and consumers.
PED > 1: elastic demand -supply highly elastic - consumer bears greatest burden -
-¨LQTXDQWLW\GHPDQGHGH[FHHGVWKH¨LQSULFH higher sales price
PED = 1: unit elastic demand -supply highly inelastic - borne by producer - price will
-¨LQSULFHUHVXOWVLQDQLGHQWLFDO¨LQquantity demanded increase slightly, after-tax amount will decrease
PED = 0: perfectly inelastic demand significantly.  
-DQ\¨LQSULFHLVPHWZLWKQR¨LQTXDQWLW\GHPDQGHG8QOLNHO\
3(' ’SHUIHFWO\HODVWLFGHPDQG
-DQ\¨LQSULFHOHDGVWRDQLQILQLWH¨LQTXDQWLW\GHPDQGHG Price controls and PES
-common policy in rich countries a timed at assisting
 
The determinants of PED Applications: farmers - use of minimum prices for agricultural
Substitutes - more responsive if large number of substitutes -Analyze effects of changing commodities.
Proportion of income - demand for goods that make up large incomes among consumers & -e.g. subsidies, import, export, price controls - ensure
proportion of a consumer's income - more elastic - large % ∆ taxpayers fairness.
Luxury/necessity ± necessities = less, luxury = more (elastic) -firm ± production #s, more efficient -Price floor is set above equilibrium - guaranteed, not sold
Addictive/not ± addictive ± relatively inelastic -XED < 1 - cross price inelastic level of output will be bought by commission.  
Time to respond - immediately ± no substitute - inelastic -XED = 1 - unit elastic -governments ± tax raise/lower ±
  -XED > 1 - cross price elastic increase/decrease disposable
Plots Total revenue -XED = 0 - perfectly inelastic   income
Horizontal ± elastic at each price and
quantity (QA2 QA1 ) QA1
Vertical ± inelastic
Middle ± neither/unit
combination, find
point revenues
YED =
maximized. (Y2 Y1 ) Y1 Elastic - ¨LQLQFRPHZLOOOHDGWR
YED = Demand vs. income larger % change in quantity demanded
Applications -positive ± normal good Inelastic - % ¨LQLQFRPHZLOOOHDGWR
-Allows businesses to make informed & sound decisions (rise income, greater demand) smaller % change in quantity demanded
-PED is not constant across all prices
-higher price - more responsive, lower price - less sensitive -negative ± inferior good Unit elastic -  ¨ LQ LQFRPH will lead to
-e.g. decrease in price = increase demand = increase total revenue (rise income, less demand) identical % ∆ in quantity demanded
-as price continues falling demand will increase but revenues will fall
-% increase in quantity demanded is proportionally smaller than % -producing at Q & P combination along inelastic range - benefit by
decrease in price   reducing output and increasing price, unresponsive anyway, revenues
will increase
Total revenue test: -allows us to determine whether -producing at Q & P combination along elastic range - benefit from
demand is elastic or inelastic by examining the impact lowering price - relatively price insensitive.  
of change in price on total revenue (PxQ)
-When demand is elastic, an increase in price causes a
fall in total revenue, while a decrease in price causes a elasticity - measures how much one factor changes in
rise in total revenue.
-When demand is inelastic, an increase in price causes response to a change in a different factor.
an increase in total revenue, while a decrease in price  
causes a fall in total revenue.
-When demand is unit elastic, a change in price does not
cause any change in total revenue.
CHAPTER 4 ² ELASTICITIES