Elasticity flashcards

Elasticity measures how responsive one economic variable is to a change in another. Students must understand four main types: price elasticity of demand (PED), price elasticity of supply (PES), income elasticity of demand (YED), and cross elasticity of demand (XED). Each is calculated as a percentage change in quantity divided by the percentage change in the relevant variable. PED values between 0 and -1 indicate inelastic demand, whilst values beyond -1 indicate elastic demand. YED distinguishes normal goods from inferior goods, and XED identifies substitutes from complements. Elasticity has important real-world applications, including how firms set prices to maximise revenue and how governments predict the effects of taxation. Understanding the determinants of each elasticity type, such as availability of substitutes or time period, is essential for higher-level analysis.

1. Card 1

   What does price elasticity of demand (PED) measure?

   PED measures how responsive the quantity demanded of a good is to a change in its own price, calculated as % change in quantity demanded divided by % change in price.

2. Card 2

   What does a PED value of -0.4 tell us about demand?

   A PED of -0.4 means demand is price inelastic; a 1% rise in price leads to only a 0.4% fall in quantity demanded, so consumers are relatively unresponsive to the price change.

3. Card 3

   State two determinants of price elasticity of demand.

   The availability of substitutes is key — more substitutes make demand more elastic. The proportion of income spent on the good also matters; expensive items tend to have more elastic demand.

4. Card 4

   How does PED affect a firm's total revenue when it raises its price?

   If demand is price inelastic, raising price increases total revenue. If demand is price elastic, raising price reduces total revenue, because the fall in quantity outweighs the higher price.

5. Card 5

   What is the formula for income elasticity of demand (YED)?

   YED = % change in quantity demanded divided by % change in income. A positive value indicates a normal good; a negative value indicates an inferior good.

6. Card 6

   What distinguishes a luxury good from a necessity using YED?

   A luxury good has a YED greater than +1, meaning demand rises proportionally more than income. A necessity has a YED between 0 and +1, so demand rises but less than proportionally.

7. Card 7

   What does a positive cross elasticity of demand (XED) indicate?

   A positive XED indicates the two goods are substitutes; a rise in the price of one good increases demand for the other, for example butter and margarine.

8. Card 8

   What does a negative XED value tell us about two goods?

   A negative XED shows the goods are complements; a rise in the price of one reduces demand for the other, for example cars and petrol.

9. Card 9

   What does price elasticity of supply (PES) measure?

   PES measures how responsive the quantity supplied of a good is to a change in its price, calculated as % change in quantity supplied divided by % change in price.

10. Card 10

    State two factors that make supply more price elastic.

    A longer time period allows producers to adjust output, making supply more elastic. Greater spare productive capacity also means firms can increase output quickly in response to a price rise.

11. Card 11

    Why does the burden of an indirect tax depend on PED and PES?

    When demand is price inelastic relative to supply, consumers bear more of the tax burden. When supply is inelastic, producers bear more. The tax incidence splits according to relative elasticities.

12. Card 12

    What is meant by perfectly inelastic demand and what does it look like on a diagram?

    Perfectly inelastic demand means quantity demanded does not change at all when price changes; PED equals zero. The demand curve is a vertical straight line on a price-quantity diagram.

• Many students confuse the sign of PED, forgetting it is normally negative, and incorrectly compare values by saying -0.3 is more elastic than -0.8 because -0.3 is the larger number.
• Students often state that inelastic demand means consumers do not respond to a price change at all, when in fact it simply means they respond proportionally less than the price change.
• A common error is assuming that a negative XED always means one good is inferior, when a negative XED actually identifies the two goods as complements, not inferior goods.

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