2.2.1 Price elasticity of Demand

Question 1

Price elasticity of demand

Answer 1

Measures the response of the quantity demanded to changes in price, and extent of the changes of both variables

Question 2

Price elastic demand

Answer 2

Small changes in price cause relatively large changes in QD → Quantity demanded changes by a higher percentage than the price

Question 3

Price inelastic demand

Answer 3

Large changes in price cause relatively small changes in QD → Quantity demanded changes by a lower percentage than price

Question 4

PED

Answer 4

Demand for most things is higher at low prices and lower and high prices.
- The term for the responsiveness of quantity demanded to price changes is price elasticity of demand

• Demand is responsive → price elastic
• Price has little impact on quantity bought → price inelastic

Question 5

how to calculate PED and answer

Answer 5

percentage change in QD/percentage change in price

As quantity demanded falls when price rises and vice versa, the answer should be negative (negative correlation on the graph)

Question 6

interpreting PED

Answer 6

• Any figure for PED between 0 and -1 shows price inelastic demand → quantity changed less than price
• Smaller relative change in demand means less price elastic demand so the number is closer to 0
• Any figure beyond -1 shows price elastic demand and the further the figure moves beyond -1, the more price elastic demand will be

Question 7

describe a product being perfectly inelastic

Answer 7

PED = O
- prices has no effect on quantity

Question 8

describe a product being inelastic

Answer 8

PED = 0 to -1

• Quantity demanded changes by a smaller percentage as a result of price changes

eg necessities, giffen goods, water

Question 9

describe unit elasticity

Answer 9

PED = -1
- Quantity demanded changes by the same % as price

• At any given price + quantity the area under the curve is equal at any other points

Question 10

describe a product being elastic

Answer 10

PED = -1 to -infinity
- Price changes lead to a bigger percentage change in QD

Eg luxury

Question 11

describe a product being perfectly elastic

Answer 11

PED = -infinity
- Any price increase causes demand to fall to 0, and a price cut leads to more demand than the firm can cope with

Eg commodity markets (only ever one price at any one point in time)

Question 12

name 5 influences on PED

Answer 12

1. necessity
2. substitutes
3. time
4. share of income a product takes
5. number of uses a product has

Question 13

necessity and PED

Answer 13

• If we need it to survive or cannot deal without it, price hardly influences whether we buy it or not (eg energy, necessities like food) → customer perception
• If something is more casual/impulse buy (minor luxury) demand should be more price elastic
• The product or market makes the difference: food vs meat (eg beef), rail travel and peak times

Question 14

substitutes

how do firms combat close substitutes

Answer 14

• Availability and closeness of substitutes influence PED → habit, tastes and limited suitability of substitutes should make price inelastic (eg water)
• Close substitutes: advertising and other marketing tries to differentiate products: demand increases and price sensitivity is limited so substitutes become less attractive in comparison → more INELASTIC
• Firms producing undifferentiated items (cheap unbranded clothes) → the demand curve facing an individual producer is very price elastic so any price increase makes their product unsaleable
• There are many other options so the seller has to accept the market price

Question 15

time

Answer 15

takes time to adjust to price changes –> longer time = more elastic it will be

Question 16

share of income

Answer 16

• Expensive items taking a high share of income can have a higher P elasticity → more ELASTIC
• PED will be low if the product only takes a small share of income → more INELASTIC

Question 17

relationship between PED and total rev

why not always true

Answer 17

• When supplier increases price:
  Higher price increases the revenue per unit but reduces the number of units sold
  Price inelastic → quantity changes more than price

With an elastic demand curve (horizontal) much bigger change in demand → revenue = p x q on diagrams

where demand is price inelastic
- Increasing price increases total revenue
- Decreasing price would decrease total revenue

Where demand is price elastic
- Increasing price reduces total revenue
- Reducing price would increase total revenue

Increase in sales does not always equal an increase in revenue
- increase in sales = increase in production and costs
- Extra sales could lead to producing more and higher costs, total costs will rise as well as total revenue
Costs > revenue → falling profits

Question 18

problems for firms in markets with many suitable substitutes

Answer 18

In a competitive mass market (rivals and similar products), we can expect price elastic demand
- Most will not increase price as revenue and sales will fall but can only control costs for profit
- Price cut could increase sales increase but could reduce/destroy profit margin - - in competive market
Not essential products → price elastic

Question 19

firms with few close subs –> small businesses in niche markets

Answer 19

• Demand is less price sensitive: in niche markets successful differentiation from the few markets can give a firm market power
• Confident firms in their price inelasticity of demand may have a small drop in sales if price increases and higher prices can increase sales revenue and profit → attractive so firms want less price elastic D curves

Question 20

how do firms gain market power

Answer 20

Firms have more market power and are stronger when their demand is price inelastic
- Firms strive to differentiate their products and build strong brand images
- Use market research to target specific groups of customers with what they want
When successful, PED of their product falls, becomes more inelastic → price and profit can increase