Economics CFA

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Author:
brundhak
ID:
32771
Filename:
Economics CFA
Updated:
2010-09-04 20:22:54
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Econ
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Description:
Reading 13 - Elasticity
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  1. Price elasticity of demand
    • a units-free measure of the responsiveness of the quantity demanded of a good to a change in its price when all other influences on buyers' plans remain the same
    • Price elasticity of demand = % change in quantity demanded / % change in price ... use absolute value so ignore the minus sign
    • % change in quantity demanded = (Orginal quant. - New quant.) / average of old and new quant.
    • % change in price = (Orginal price - New Price) / average of old and new price
  2. Elasticity is a units-free measure because
    the % change in each variable is independent of the units in which the variable is measured. The ratio of the 2 %s is a # without units.
  3. Perfectly inelastic demand
    • Quantity demanded is constant regardless of the price changes. The price elasticity of demand is 0.
    • ex of good: low price elasticity of demand = insulin.
  4. Unit elastic demand
    if the % change in the quantity demanded equals the % change in price, then price elasticity = 1 and the good is said to have a unit elastic demand.
  5. Inelastic demand
    % change in the quantity demanded is less than the percentage change in price (price elasticity is between 0 and 1)
  6. perfect elastic demand
    • if the quantity demanded changes by an infinitely large % in response to a tiny price change, then the price elasticity of demand is infinity
    • ex: soft drink machine located side by side
  7. elestic demand
    if % change in quantity demanded exceeds % change in price, the price elasticity of demand is greater than 1 and the good is said to have an elastic demand.
  8. The change in total revenue depends on the elasticity of demand in the following ways:
    • - If demand is elastic: 1% price cut increases quantity sold by more than 1% & total rev. increase
    • - If demand is inelastic: 1% price cut increases quantity sold by less than 1% & total rev. decrease
    • - If demand is unit elastic: 1% price cut increases quantity sold by 1% & total rev. doesn't change
  9. total revenue test
    • is a method of estimating the price elasticity of demand by observing the change in total rev. that results from a change in the price, when all other influences on the quantitiy sold remain same
    • - price cut ^ total rev. demand = elastic
    • - price cut decrease total rev. demand = inelastic
    • - price cut leave total rev. unchange, demand = unit elastic
  10. magnitude of the elasticity of demand depends on
    • - the closness of substitutes
    • - the proportion of income spent on the good = higher % of income a good cost the more elastic the demand
    • - the time elapsed since a price change = the more time that has passed the more elastic the demand
  11. Cross Elasticity of Demand
    • Measures the influence of a change in price of a subsitute or complement.
    • Measure of the responsiveness of the demand for a good to a change in the rpice of a substitute or complement, other things remainig same
    • - cross elasticity of demand = % change in quantity demanded / % change in price of a substitute or complement
    • - positive for a substitute and negative for a complement
    • - the larger the cross elasticity of demand the greater the change in demand and the larger the shift in the demand curve
    • - if two items are not related then the cross elasticity is 0.
  12. Income Elasticity of Demand
    • Responsiveness of the demand for a good or service to a change in income, other things remaining the same.
    • - income elasticity of demand = % change in quantity demanded / % change in income
    • - Greater than 1 (normal good, income elastic) = as income ^, % of income spent on good ^
    • - Positive and less than 1 ( normal good, income inelastic) = as income ^, % of income spent on good decreases
    • - Negative (inferior good) = as income ^, % of income spent on good decreases
  13. Elasticity of Supply
    • Measures the responsiveness of the quantity supplied to a change in the price of a good when all the other influences on selling plans remain the same
    • - Elasticity of supply = % change in quantity supplied / % change in price
    • - No matter how steep the supply curve is , if it is linear and pases through the origin, supply is unit elastic
  14. Magnitude of the elasticity of supply depends on
    • - Resource substitution possibilities = when good is produced in many countires or can be obtained easily then it is highly elastic.
    • - Time frame for the supply decision > momentary supply (response of quantitiy supplied immediately following price change)
    • > long-run supply (response of quantitiy supplied to a change in price after all the technologically possible ways of adjusting supply have been exploited)
    • > short-run supply (the quantity supplied responds to a price change when only some of the technologically possible adjustments to production have been made) producers can control quantitiy supplied quickly

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