2.5 Elasticities of Demand

Question 1

What is PED

Answer 1

Measure of the responsiveness of the quantity of a good demanded to changes in its price

Question 2

How to calculate PED

Answer 2

%change in QD / %change in P

Question 3

Explain PED changing and the demand curve

Answer 3

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

Question 4

When is PED inelastic and show the graph for it

Answer 4

0 < PED < 1

Question 5

When is PED elastic and show the graph for it

Answer 5

1 < PED < infinity

Question 6

When is PED unit elastic and show the graph for it

Answer 6

PED = 1

Question 7

When is PED perfectly inelastic and show the graph for it

Answer 7

PED = 0

Question 8

When is PED perfectly elastic and show the graph for it

Answer 8

When PED = infinity

Question 9

Determinants of PED

Answer 9

number and closeness of substitutes
necessities vs luxuries
time period
portion of income spent on good

Question 10

Explain the determinant of PED of number of substitutes

Answer 10

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

Question 11

Explain the determinant of PED of necessities vs luxuries

Answer 11

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)

Question 12

Explain the determinant of PED of time period

Answer 12

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

Question 13

Explain the determinant of PED of proportion of income spent

Answer 13

The larger proportion of income needed to buy a good, the more elastic the demand

Question 14

Relationship between PED and total revenue for different elasticities

Answer 14

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

Question 15

PED and firm pricing decisions

Answer 15

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

Question 16

PED and government-decision making

Answer 16

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

Question 17

Why do primary commodities have a lower PED compared to PED of manufactured products

Answer 17

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

Question 18

What is YED

Answer 18

Income elasticity of demand is a measure of the responsiveness for demand to changes income

Question 19

How to calculate YED

Answer 19

% change in QD / % change in income

Question 20

Primary commodities

Answer 20

natural resources or products that come directly from the factor ‘land’, which have not been transformed through any production process.

Question 21

What does a positive income elasticity of demand indicate ( YED > 0)

Answer 21

The good is normal, demand for the good and income change in the same direction

When one increases, the other one also increases

Question 22

What does it mean if there is a negative income elasticity of demand ( YED < 0)

Answer 22

Good is inferior, demand for good decreases when income increases e.x used clothes

Question 23

What does it mean if a good has a YED that is positive but less then one (YED < 1)

Answer 23

It has income inelastic demand and the good is a necessity

A % in income produces a smaller % increase in quantity demanded

Question 24

What does it mean if a good has a YED that is positive but greater then one (YED > 1)

Answer 24

Good is income elastic, and is a luxury goof

A percentage increase in come producers a larger percentage increase in quantity demanded

Question 25

Importance of YED for firms

Answer 25

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

Question 26

YED and sectoral structure of the economy

Answer 26

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