1.2.3 Price Elasticity of Demand Flashcards
What is Elasticity of Demand?
Elasticity of demand is an attempt to measure the responsiveness of quantity demanded to
changes in other variables: its own price, the price of other goods and real income.
How responsive is an elastic good?
Relatively responsive
How responsive is an inelastic good?
Relatively unresponsive
What is Price elasticity of demand (PED)?
This is the responsiveness of demand to a change in the price of the good
What is the formula for PED?
% Change in Quantity demanded / % Change in Price
Summarise Unitary elastic PED
Unitary elastic PED is where PED=1
- quantity demanded changes by exactly the same percentage as price.
- This would be shown as a reciprocal curve.
Summarise Relatively elastic PED
Relatively elastic PED is where PED>1
- quantity demanded changes by a larger percentage than price so demand is relatively responsive to price.
- The curve will be more sloping
Summarise Relatively inelastic PED
Relatively inelastic PED is where PED<1
- quantity demanded changes by a smaller percentage than price so demand is relatively unresponsive to price.
- The curve will be steep.
Summarise perfectly elastic PED
Perfectly elastic PED is where PED=infinity
- a change in price means that quantity falls to 0 and demand is very responsive to price.
- This would be shown by a horizontal line
Summarise perfectly inelastic PED
Perfectly inelastic PED is where PED=0
- a change in price has no effect on output so demand is completely unresponsive to price.
- This would be shown by a vertical line.
What factors effect PED?
- Availability of Substitutes
- Time
- Necessity
- How large of a % of total expenditure
- Addictive
Explain how availability of Substitutes effects PED?
- If a product has lots of substitutes (for example instead of buying Coke you could buy Pepsi), people will switch to other products when prices go up.
- Therefore, PED will be elastic. If there are no substitutes, then the demand curve will be inelastic since even if prices go up, people will have to buy that good if they want it as there are no alternatives.
Explain how Time effects PED?
- The longer the time, the easier it will be for a person to find an alternative product/supplier of the product so the more elastic the good is.
- In the short term, many goods are inelastic as people may not even notice the price difference.
Explain how Necessities effect PED?
If you need something, the demand curve will be inelastic because even if the price goes up, you still need to buy it.
Explain How large of a % of total expenditure can effect PED
- If a good/service represents a very small percentage of a person’s expenditure, a significant increase in price will have a relatively small impact on how much they buy of that product so it will be inelastic e.g.
matches.
Explain how addiction effects PED?
If a product is addictive, then the demand curve will be inelastic. No matter how high prices are, people will still buy the good to fulfil their addiction.
What is Income elasticity of demand (YED)?
This is the responsiveness of demand to a change in income.
What does the gradient of an inelastic curve look like?
Steep Gradient
What does the gradient of an elastic curve look like?
Shallow Gradient
What is the formula for Income elasticity of demand (YED)
%change in quantity demanded / %change in income
Name the Good when YED>0
Normal Goods
Name the Good when YED<0
An Inferior Good
Name the Good when YED>1
A Luxury Good
Why is Income elasticity of demand (YED) significant?
- It is important for businesses to know how their sales will be affected by changes
in the income of the population - If the economy is improving and people’s incomes are rising it is vital that a business knows whether this is likely to increase their sales or not.
- It may have an impact on the type of goods that a firm produces
- During times of prosperity, firms might produce more luxury goods and less inferior goods.
What is Cross elasticity of demand (XED)?
This is the responsiveness of demand for one product (x) to the change in price of another
product (y).
Formula of Cross elasticity of demand (XED)
%change in quantity demanded of x / %change in price of y.
Substitutes are where XED…..
XED>0
Example of when Substitutes are where XED>0
- An increase in the price of good B will increase demand for good A.
- For example, Coca Cola and Pepsi are substitutes.
Complementary goods are where…
XED<0
Example of when complementary goods are where XED<0
- An increase in the price of good B will decrease demand for good A.
- One example is DVDs and DVD players
Unrelated goods are where….
XED = 0
What is the significance of XED?
- Firms need to be aware of their competition and those producing complementary goods.
- They need to know how price changes by other firms will impact them so they can take appropriate action.
