2.5 Elasticities Of Demand Flashcards
What is PED
Measure of the responsiveness of the quantity of a good demanded to changes in its price
How to calculate PED
%change in QD / %change in P
Explain PED changing and the demand curve
On a demand curve, demand is price elastic at high prices and low quantities
Demand is price inelastic at low price and large quantities
At the mid point demand is unit elastic
When is PED inelastic and show the graph for it
0 < PED < 1
When is PED elastic and show the graph for it
1 < PED < infinity
When is PED unit elastic and show the graph for it
PED = 1
When is PED perfectly inelastic and show the graph for it
PED = 0
When is PED perfectly elastic and show the graph for it
When PED = infinity
Determinants of PED
- number and closeness of substitutes
- necessities vs luxuries
- time period
- portion of income spent on good
Explain the determinant of PED of number of substitutes
The more substitutes the more elastic the goods demand is
If price of a good with many substitutes increase, quantity demanded fall as they switch to the cheaper products
Explain the determinant of PED of necessities vs luxuries
Necessities are goods or services considered essential, while luxuries are not essential
demand of necessities (food, medications) is more inelastic then demand for luxury (rings, cars)
Explain the determinant of PED of time period
The longer the time period in which a consumer makes a purchasing decision, the more elastic the demand
As time goes by consumers have the opportunity to evaluate the good and get information on alternatives
Explain the determinant of PED of proportion of income spent
The larger proportion of income needed to buy a good, the more elastic the demand
Relationship between PED and total revenue for different elasticities
Total revenue is the amount of money received by a firm when they sell a good
When demand is elastic an increase in price causes a fall in total revenue, while a decrease in price causes a rise in total revenue
When demand is inelastic and increase in price causes an increase in total revenue, while a decrease in price causes a fall in total revenue
PED and firm pricing decisions
Firms must consider PED when changing prices
Firms may want to increase total revenue, so they drop price if demand is elastic, or increase price if demand is inelastic
PED and government-decision making
If governments are interested in increasing their tax revenues, the PED of goods must be considered
The more inelastic demand is for the goods, the greater the government tax revenues
Why do primary commodities have a lower PED compared to PED of manufactured products
Primary comedies are goods arising directly from the use of natural resources e.x agricultural, fishing and forestry products
Manufactured products are good produced by labor e.x computers, cars
Primary commodities have a low PED as they are necessities and have no substitutes (food,oil)
Manufactured products have high PED as they usually have substitutes
What is YED
Income elasticity of demand is a measure of the responsiveness for demand to changes income
How to calculate YED
% change in QD / % change in income
What does a positive income elasticity of demand indicate ( YED > 0)
The good is normal, demand for the good and income change in the same direction
When one increases, the other one also increases
What does it mean if there is a negative income elasticity of demand ( YED < 0)
Good is inferior, demand for good decreases when income increases e.x used clothes
What does it mean if a good has a YED that is positive but less then one (YED < 1)
It has income inelastic demand and the good is a necessity
A % in income produces a smaller % increase in quantity demanded
What does it mean if a good has a YED that is positive but greater then one (YED > 1)
Good is income elastic, and is a luxury goof
A percentage increase in come producers a larger percentage increase in quantity demanded
Importance of YED for firms
The higher the YED for a good or service, the greater the expansion of its market is likely to be in the future - Producers are infested in producing in an expanding market
In periods of recession, goods with low YEDS can avoid largest falls in sales, while inferior goods can increase its sails
YED and sectoral structure of the economy
As an economy grows, and incomes increase, demand for primary goods, such as agricultural products does
not greatly increase because they have income–inelastic demand.
When incomes grow, people do not tend to
buy more agricultural goods – extra income tends to be spent on manufactured goods
Output in secondary sector will increase at a faster rate than Primary
