2.5 PED Flashcards
elasticity
responsiveness of a variable to changes in any of the other variables
PED
A measure of the responsiveness of the quantity of a good demanded to changes in its price
calculation of PED
PED = %change in Qd / %change in P
range of PED for elastic
PED > 1
range of PED for inelastic
PED < 1
elastic
% change in Qd ? % change in price
% change in Qd > % change in price
perfectly inelastic demand
Definition: Quantity demanded is completely unresponsive to price
- PED = 0
- e.g. cocaine = people with high level of drug addiction
- e.g. painting by famous deceased artists = Van Gogh
perfectly elastic demand
-Definition: quantity demanded is infinitely responsive to price
- PED = ∞
- Vending machine A vs Vending machine B
- You are trying to buy a drink from the vending machine
- The drinks and their prices provided by both machines are the same
- Which vending machine would you go for if there is a 10 cents increase for all drinks in vending machine A?
inelastic
% change in Qd ? % change in price
% change in Qd < % change in price
what happens if there is perfectly elastic demand (with reference to changes in price)
- If P increases, 0 Q will be demanded
- If P decreases, infinite Q will be demanded
unit elastic demand
- Definition: percentage change in quantity demanded equals percentage change in price
- PED = 1
- e.g. Mr. Sun loves helmets so much he spends ALL HIS MONTHLY SALARY on helmets
- If the price of helmets is reduced by 5%, how many more helmets can Mr. Sun get? → he can get 5% more helmets
determinants of PED
1) Number and closeness of substitutes
- The more the substitutes, the more price elastic the demand
2) Necessities vs luxuries
- Necessities = less elastic
- Luxuries = more elastic
3) Length of time
- More time to consider = more elastic
4) Proportion of income spent on good
- A good that takes up a very small proportion of one’s income = less elastic
application of PED - fishball analogy
fishball produced at very low cost + high price elasticity
lower price slightly (loss) = large increase in quantity demanded
gain > loss –> total revenue
increase in %Qd > decrease in %P
Why many primary commodities have a lower PED compared with the PED of manufactured products (generalisation)
- lower PED = more inelastic
- primary commodities are necessities
- less or no substitutes
- less time to consider — needs need to be more urgently fulfilled
- takes up a small proportion of one person’s income
e.g. food
- necessity
- no substitutes
e.g. housing (exception from the manufactured products which have lower PED)
profit =
profit = revenue - cost
what is the relationship between elasticity and revenue
Elastic demand
- Revenue increase with price decrease, vice versa
Inelastic demand
- Revenue remain the same with price increase, vice versa
Example: HK people eat Thailand imported rice, but flooding occurs and destroyed most fields in Thailand
how does this affect the price of rice and producers’ revenue
price of rice increases
- increase the price of rice
- supply shifts from S1→S2
- price increase from P1→P2
producers’ total revenue increases
- gain > loss
- because of price increase
- because price inelastic → change in price > change in quantity demanded
Why is it important for the government to consider PED when imposing indirect tax on goods and services?
- less elastic = consumers are less sensitive to the increasing price of goods from taxes = more tax revenue
changes in PED moving down the demand curve
- gets more positive as it moves down the demand curve (as price decrease and quantity increase)
- lower PED as it moves down the curve
midpoint of demand curve =
midpoint of demand curve = unitary elastic demand
elastic/inelastic portion of demand curve
- above midpoint → entire portion is elastic
- below midpoint → entire portion is inelastic
what happens if you reduce price at the elastic portion of the demand curve
in elastic part → reduce price, TR will increase → responsive → % increase in Qd > % decrease in price
what happens if you reduce price at the inelastic portion of the demand curve
in inelastic part → reduce price → TR will decrease → unresponsive, only changing the price
