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Elasticity...and some quiz questions!

In the last post, we looked at aggregate demand curves and aggregate supply curves. We know that for a given product, demand is higher if the price is lower and supply is higher if the price is higher, and how in a competitive market, the market price will tend to the intersection of the two curves.

Now if we know that demand is higher if the price is lower, the next question to ask is this:

How much will demand increase in response to a price decrease?

The answer is all about elasticity.



For some products, a price increase or decrease of 1% will lead to a corresponding decrease or increase in demand of more than 1%. Such goods are said to have 'elastic' demand.

For other products, a price increase or decrease of 1% will lead to a corresponding decrease or increase in demand of less than 1%. Such goods are said to have 'inelastic' demand.

Raising the price of a product with inelastic demand increases total revenue for the supplier since the reduction in the quantity demanded is less than the effect of the price increase. However, since elasticity will vary at different points along the demand curve, suppliers in this situation can't just keep on increasing the price of their products - sooner or later, demand will become elastic.

It's not just demand that is elastic or inelastic. The same can be said for supply.

And elasticity can relate to factors other than price. A good one is income. A good whose demand doesn't change much if consumers' aggregate income changes is said to have income inelastic demand.

The reason for posting about elasticity now is that it explains why, when the VAT rate goes up on Tuesday, not all goods will increase in price by the same amount. More on that in the next post.

In the meantime, some quiz questions for you:

1. Give an example of something where you would expect demand to be price elastic. Explain why.
2. Give an example of something where you would expect demand to be price inelastic. Explain why.
3. Give an example of something where you would expect demand to be income elastic. Explain why.
4. Here's a good one: give an example of something where you would expect demand to be negatively price elastic; that is a good or service where an increase in price would actually lead to an _increase_ in demand.

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Comments

( 1 comment — Leave a comment )
king_of_wrong
Jan. 1st, 2011 09:26 pm (UTC)
Ooh, a quiz!

1. Books - optional luxury goods, and releasing new hardbacks at 50% discount seems intended to exploit elasticity.
2. Bread - got to eat something, no matter how much it costs.
3. BMWs - easy to make an old car last a bit longer if income is tight, a nice treat if it's not.
4. Bling - the more the price goes up, the better to flaunt one's wealth.

#3 gave me more trouble than #4: everything I could think of was also price elastic.

Thanks for the economics posts, I'm enjoying them :)
( 1 comment — Leave a comment )