knowverseHow strongly do buyers and sellers respond to changing prices? Try 10 questions on elasticity, revenue and who bears a tax.
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It measures how quantity demanded responds to a change in its own price.
When we focus specifically on how buyers react to price, we call it the Price Elasticity of Demand.
From the Knowverse course text.
Elastic demand has a magnitude greater than one.
In basic terms, demand is elastic if the percentage change in quantity is larger than the percentage change in price. If price changes by 5% and quantity changes by 10%, that's considered a substantial, elastic reaction.
From the Knowverse course text.
Inelastic demand means a relatively small percentage response.
Inelastic demand occurs when the quantity demanded responds only slightly to changes in the price.
From the Knowverse course text.
Alternatives make it easier for buyers to switch.
Beyond being a necessity, another factor changes how we react to prices: the availability of close substitutes.
From the Knowverse course text.
Time allows buyers to find alternatives or change habits.
Yes. In the short term, demand is often more inelastic because people haven't found substitutes yet. For example, if gas prices rise today, you still have to drive to work. But over a year, you might buy a more fuel-efficient car or move closer to work, making your long-term demand more elastic.
From the Knowverse course text.
Revenue is the money received from sales.
Total revenue is the full amount of money that buyers pay and sellers receive for a specific good.
From the Knowverse course text.
The percentage quantity reduction outweighs the price increase.
If demand is elastic, an increase in price leads to a decrease in total revenue.
From the Knowverse course text.
Demand for an inferior good falls as income rises, other things equal.
These are called Inferior Goods, and they have a negative income elasticity.
From the Knowverse course text.
A higher price of one substitute can raise demand for the other.
For substitutes, the cross-price elasticity is always a positive number.
From the Knowverse course text.
Relative responsiveness determines burden, rather than the legal remitter alone.
This leads us to a major rule: the Tax Burden falls more heavily on the side of the market that is less elastic.
From the Knowverse course text.
See the answer and explanation for each question below.
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Elasticity compares percentage changes. Price elasticity of demand asks how much quantity demanded responds to a price change, with other influences held constant. Using percentages makes comparisons possible across goods sold in different units. A large percentage response in quantity indicates greater sensitivity than a small response to the same percentage price change.
Demand is elastic when the percentage quantity response exceeds the percentage price change in magnitude. It is inelastic when the response is smaller. Close substitutes can make switching easier, and more time may allow buyers to adjust their habits. Elasticity therefore depends on the product, circumstances and period being considered.
In basic terms, demand is elastic if the percentage change in quantity is larger than the percentage change in price. If price changes by 5% and quantity changes by 10%, that's considered a substantial, elastic reaction.
From the Knowverse course text.
Total revenue is price multiplied by quantity sold. Along a demand curve, a price increase reduces total revenue when demand is elastic over that change. With inelastic demand, the price effect outweighs the quantity reduction. Revenue is different from profit, so this relationship alone does not settle a business's costs or earnings.
Income elasticity relates quantity demanded to income. Normal goods have positive income elasticity, while inferior goods have negative income elasticity. Cross-price elasticity examines two goods: substitutes usually have a positive relationship and complements a negative one. In the supply-and-demand tax model, the less elastic market side bears more of the tax burden.
This leads us to a major rule: the Tax Burden falls more heavily on the side of the market that is less elastic.
From the Knowverse course text.
Sources: Responsiveness and Elasticity. Each question or step includes an excerpt from the course.
