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Thank You Economics Students.
Elasticity Continued:
Determinants of PED and the Price Elasticity of
Supply, or PES.
Determinants of PED:
Substitutability
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The larger the number of substitute goods, the
greater the PED.
The elasticity of demand for a product can
depend upon how narrowly the product is
defined.
Demand for a specific brand is MORE elastic
than demand for the product in general. The
more competition, the higher the elasticity.
Determinants of PED:
Proportion if Income
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The higher the price of a good relative to a
consumer's income, the greater the PED.
The PED on a house might be higher than the
PED on a package of gum because the price
increase on a house is higher as a percentage
of the buyers income.
Determinants of PED:
Luxuries or Necessities
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The more that a good is considered a luxury
rather than a necessity, the higher its PED.
Electricity has a PED of 0.13, Bread has a PED
of 0.15 and Restaurant Meals have a PED of
2.27.
If a PED of less than 1 is in-elastic, why is the
PED of Bread 0.15 but restaurant meals have a
PED of 2.27?
Determinants of PED:
Time
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PED is more elastic the longer the time period
under consideration.
Consumers need time to adjust their habits and
decisions. It simply takes time to think and
experiment with substitutes.
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Short-run PED for gasoline = 0.2
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Long-run PED for gasoline = 0.7
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Why is PED more elastic over the long-run?
Price Elasticity of Supply
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PES is the ratio of the percentage change in
quantity supplied of a product or resource to the
percentage change in price.
It is the responsiveness of producers/firms to a
change in the price of a product.
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Change in Quantity / Average Quantity
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Divided By
Change in Price / Average Price
PES and Time...
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Time is the primary influence on PES. If a
producer has enough time to shift resources to
something else that makes more money, they
will... Therefore, PES increases for each period.
Economists break this concept down into 3
periods:
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1) Immediate / Market Period
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2) The Short-Run
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3) The Long-Run
PES & Figure 6-3
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Figure 6-3 Illustrates the time and the elasticity
of supply for a tomato farmer.
In the Immediate period, it is perfectly
inelastic... he/she is already at the market so
the slope is perfectly vertical.
In the Short-run, it is more elastic, the farmer
can shift some more resources to tomatoes.
In the Long-run, it is very elastic. If the price of
tomatoes rises, he will shift more production.
Cross Elasticity of Demand
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The ratio of the percentage change in quantity
demanded of one good to the percentage
change in price of another good.
A positive number indicates they are
substitutes.
A negative number indicates they are
complementary.
The formula is essentially the same as for PES
or PED. Refer to page 140.
Income Elasticity of Demand
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The ratio of the percentage change in quantity
demanded to a percentage change in consumer
incomes.
It measures the responsiveness of consumer
purchases to changes in income.
For Normal Goods, the Income Elasticity of
Demand is positive.
For Inferior Goods it’s negative.
The formula is essentially the same as for PES
or PED. Refer to page 141.
Questions 8, 12, and 13.
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These are excellent prep for Friday's Test.
Elasticity and Taxes
Taxes have the effect of increasing the marginal
cost of the products. This shifts the supply curve
up by the amount of the tax.
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The 5 Minute Video Below will help as an intro:
The Incidence of Tax - An Overview
Tax Incidence (Who Feels the Pain?)
Tax burden on consumer. When
demand is inelastic the tax burden is
mainly on the consumer.
Tax burden on producer. When
demand is elastic, the tax burden is
mainly on the producer.
Example - the incidence of a tax on cigarettes
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The government puts a £1 tax on each packet of cigarettes because they are harmful to
your health. The legal incidence is on the cigarette smoker. However, the local market
may have many sellers, and be highly competitive. This means that a retailer, fearing they
will lose sales, may decide to put up the price by only 50p, and pay the balance of 50p to
the government themselves. In this case, the economic incidence is shared and both are
worse off. The smoker is worse off because of the price increase of 20p, and the seller is
worse off because 10p must come out of their revenue to pay the government.
PES and Tax Incidence
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With a highly inelastic PES, the tax incidence
will mainly fall on the producer.
With a highly elastic PES, the tax incidence will
mainly fall on the consumer.
This is also true, as we saw, for PED.
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Question 14 & 15.
These are excellent prep for Friday's Test.