1.2.4 Price Elasticity of Demand Flashcards
What is Price Elasticity of Demand (PED)
A measure of how the quantity demanded of a good responds to a change in its price
PED Equation
PED = Percentage change in quantity demanded / Percentage change in price
PED = %△Qd / %△P
Percentage Change Equation
Percentage change = Change / Original x 100
What is the PED relationship?
PED has an inverse relationship
As price goes up, demand goes down
As price goes down, demand goes up
⬆️ P ⬇️ D ⬇️ P ⬆️ D
PED Elasticity
If PED = 0 Demand is perfectly inelastic –> demand does not change when the price changes
If PED = 0 - 1 (PED<1) Demand is inelastic –> % change in demand is smaller then the percentage change in price
If PED = 1 Demand is unit elastic –> % change in demand is the same as the % change in price.
If PED > 1 Demand is elastic –> demand responds more than proportionately to a change in price
PED Elastic
If the Price Elasticity of Demand is greater than 1 (ignoring the minus sign) the product is price elastic.
For price elastic products, the % change in demand is greater than the % change in price.
Elastic goods’s Characteristics
- Change in price leads to a bigger percentage change in demand
1. They are luxury goods –> e.g. sports cars
2. Expensive and big % of income –> e.g. sports cars and holidays
3. Goods with many substitutes and is a very competitive market
4. Bought frequently
PED Inelastic
If the Price Elasticity of Demand is less than 1, it’s price elastic
For price inelastic products, the % change in demand is less than the % change in price
Inelastic goods’s characteristics
- Change in price leads to a smaller percentage change in demand
1. Few or no close substitutes –> e.g. petrol, cigarettes
2. Necessities –> e.g. If you have a car, you need to keep buying petrol, even if price of petrol increases
3. Addictive –> e.g. cigarettes
4. Cost a small % of income or are bough infrequently
what are the Factors and Determinants of PED?
- The availability of substitutes –> (A substitute is a product that can be used to replace another because customers see them as being very similar products) The closer the substitutes and the more that are available the higher the Price Elasticity of Demand. The fewer substitutes a good has the less elastic demand tends to be
- The price of competitors goods –> If the price of goods in competition with a product increase this will affect demand and price elasticity of demand
- Time Period –> In the long run demand becomes more price elastic as it becomes easier to change to alternatives because consumers have had the time to shop around.
- Income –>
- Nature of the good
- -> A luxury good will be 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 - Brand loyalty –> Loyal customers won’t switch even if the price goes up, so this makes the product less price elastic.
PED Example
When the type of a toy car increased from 50p to 70p the demand for them fell from 15 cars to 10 cars.
The percentage change in quantity demanded would be: change in demand / original demand x 100
-5 / 15 X 100 = –33.33%
The percentage change in price would be: change in price / original price x 100
20 / 50 X 100 = 40%
so PED = – 33.33% / 40% = –0.83
Sales Revenue Equation
Sales Revenue = Selling price x sales volume
Note: Sales volume is the number of units sold in a given time period
Note: Sales volume = sales revenue / selling price
If a good has ELASTIC demand, then:
Reduction in price, what will happen to total revenue?
A reduction in price will increase a business’s total revenue
If a good has ELASTIC demand, then:
Increase in price, what will happen to total revenue?
An increase in price will reduce the business’s total revenue
If a good has INELASTIC demand, then:
Reduction in price, what will happen to total revenue?
A reduction in price will reduce the business’s total revenue
