OCR Economics A-level Microeconomics PDF

OCR​ ​Economics​ ​A-level Microeconomics Topic​ 2:​ ​How Competitive Markets Work 2.4 Elasticity Notes www.pmt.education Elasticity is how responsive demand or supply is to a change in price. Price elasticity of demand The pric...

OCR​ ​Economics​ ​A-level Microeconomics Topic​ 2:​ ​How Competitive Markets Work 2.4 Elasticity Notes www.pmt.education Elasticity is how responsive demand or supply is to a change in price. Price elasticity of demand The price elasticity of demand is the responsiveness of a change in demand to a change in price. The formula for this is: A price elastic good is very responsive to a change in price. In other words, the change in price leads to an even bigger change in demand. The numerical value for PED is >1. www.pmt.education A price inelastic good has a demand that is relatively unresponsive to a change in price. PED is 0. www.pmt.education With luxury goods, an increase in income causes an even bigger increase in demand. YED > 1. For example, a holiday is a luxury good. Luxury goods are also normal goods, and they have an elastic income. During periods of prosperity, such as economic growth when real incomes are rising, firms might switch to producing more luxury goods and fewer inferior goods, because demand for luxury goods will be increasing. Cross elasticity of demand Cross elasticity of demand is the responsiveness of a change in demand of one good, X, to a change in price of another good, Y. The formula for this is: Complements, substitutes and unrelated goods: Complementary goods have a negative XED. If one good becomes more expensive, the quantity demanded for both goods will fall. o Close complements: a small fall in the price of good X leads to a large increase in QD of Y. o Weak complements: a large fall in the price of good X leads to only a small increase in QD of Y. www.pmt.education Substitutes can replace another good, so the XED is positive and the demand curve is upward sloping. If the price of one brand of TV increases, consumers might switch to another brand. o Close substitutes: a small increase in the price of good X leads to a large increase in QD of Y. o Weak substitutes: a large increase in the price of good X leads to a smaller increase in QD of Y. www.pmt.education Unrelated goods have a XED equal to zero. For example, the price of a bus journey has no effect on the demand for tables. Firms are interested in XED because it allows them to see how many competitors they have. Therefore, they are less likely to be affected by price changes by other firms, if they are selling complementary goods or substitutes. The incidence of tax and effects of subsidies with different PEDs If demand is more elastic (PED>1), the incidence of the tax will fall mainly on the supplier. www.pmt.education If demand is more inelastic (PED1. www.pmt.education If supply is inelastic, an increase in supply will be expensive for firms and take a long time. PES is