1.2.3 Price Elasticity Of Demand Flashcards
Define PED
Measures the responsiveness of quantity demanded after a change in a product’s own price.
What is the formula for PED
%change in quantity demanded/%change in price
Define inelastic PED
The percentage change in quantity demanded is less than the percentage change in price
Give examples of things with an inelastic PED
Cigarettes, petrol
Goods and services that do not have many substitutes or are necessities or addictive
Define elastic PED
When the percentage change in quantity demanded is more than the percentage change in price
Give examples of things with an elastic PED
Designer clothes
Goods and services that do not have many substitutes or are luxuries
What is the PED value for a perfectly inelastic good
0
Give an example of a perfectly inelastic good
Hard drugs
What is the PED value for a price inelastic good
0-1
What is the PED value for a unitary elastic good
1
What is the PED value for a price elastic good
1-infinity
What is the PED value for a perfectly elastic good
Infinity
What are the six factors affecting PED
Proportion of income
Loyalty
Addicitiveness
Necessity or luxury
Time period
Substitute availability
Explain how proportion of income affects PED
The larger proportion of income a good constitutes, the more responsive its consumers will be to changes in price (elastic).
If a good only constitutes a small proportion of income demand is likely to be price inelastic
Explain how brand loyalty affects PED
if a consumer really likes a brand and prefers it over others then it will be more price inelastic
Explain how addictiveness affects PED
if a product is addictive or forms part of someone’s everyday life then they will be more price inelastic
Explain how necessity or luxury affects PED
A luxury good will be more price elastic as demand will be more sensitive to changes in price
A necessity good will be price inelastic as demand will be less sensitive to changes in price
Explain how time period affects PED
the longer the time period the higher the PED (elastic). Given more time other firms have the ability to produce similar products and customers have more chance of adapting their buying habits
Explain how substitute availability affects PED
The closer the substitutes and the more that are available the higher the PED (more elastic)
What is perfectly inelastic demand
Quantity demanded is entirely unresponsive to a change in price
What it unitary elastic demand
Quantity demanded changes at the same rate as price
What is perfectly elastic demand
A price increase will lead to no demand whereas a price decrease will lead to an infinite amount of demand
What is PED data useful for
Firms - in making decisions on price
Government- in making decisions on tax
Firms TR: what happens if demand is price inelastic
Firms should increase price as demand will fall by a smaller proportion and total revenue will rise
Government TR- what happens if demand demand is price inelastic
Governments should impose tax on these goods as demand falls by a smaller proportion, raising significant tax revenue. If the government subsidised such a product, the resulting price fall would not stimulate demand significantly
What may successive price rises cause
May make the good elastic in demand as consumers decide to cut back in expenditure as it has become far too expensive
Firms TR: what happens if demand is price elastic
Firms should reduce price as demand will rise by a larger proportion and total revenue will rise
Government TR: what happens if demand is price elastic
Governments shouldn’t impose tax on these goods as demand falls significantly, causing the firm to contract and redundancies to arise.
However, if the government subsidised such a good, a resulting lower price would increase demand significantly
Why may firms not be able to maximise TR for a price elastic good
May not be able to cope with the increase in demand if they have limited excess capacity. Also firms may not be able to cut the price if their price is just above average costs
Summarise PED and total revenue for each curve
Elastic demand- a decrease in price leads to an increase in revenue and an increase in price leads to a decrease in revenue
Inelastic demand- a decrease in price leads to a decrease in revenue and an increase in price leads to an increase in revenue
Unitary elastic- a change in price does not affect total revenue
What are the limitations of PED
- the data may be unreliable as figures are often estimated based on market research. A small sample may be unrepresentative and misleading
- the data may change over time eg new competitors enter the market, increasing the range of substitutes making demand more price elastic
- other things may not remain unchanged eg consumer trends
Explain how PED changes at high prices
There will be low demand so a change in price leads to a large percentage change in demand and as prices are high the price change is a small percentage change
Therefore PED=large%change/small%change so a large figure that is greater than one, demand is price elastic at high prices
How does PED change at low prices
There will be high demand so a change in price leads to a small percentage change in demand and as prices are low the price change is a large percentage change
Therefore PED=small%change/large%change so a small figure that is less than one, demand is price inelastic at low prices
