2.5 PED

Question 1

elasticity

Answer 1

responsiveness of a variable to changes in any of the other variables

Question 2

PED

Answer 2

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

Question 3

calculation of PED

Answer 3

PED = %change in Qd / %change in P

Question 4

range of PED for elastic

Answer 4

PED > 1

Question 5

range of PED for inelastic

Answer 5

PED < 1

Question 6

elastic

% change in Qd ? % change in price

Answer 6

% change in Qd > % change in price

Question 7

perfectly inelastic demand

Answer 7

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

Question 8

perfectly elastic demand

Answer 8

-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?

Question 8

inelastic

% change in Qd ? % change in price

Answer 8

% change in Qd < % change in price

Question 9

what happens if there is perfectly elastic demand (with reference to changes in price)

Answer 9

• If P increases, 0 Q will be demanded
• If P decreases, infinite Q will be demanded

Question 10

unit elastic demand

Answer 10

• 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

Question 11

determinants of PED

Answer 11

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

Question 12

application of PED - fishball analogy

fishball produced at very low cost + high price elasticity

Answer 12

lower price slightly (loss) = large increase in quantity demanded

gain > loss –> total revenue

increase in %Qd > decrease in %P

Question 13

Why many primary commodities have a lower PED compared with the PED of manufactured products (generalisation)

Answer 13

• 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)

Question 13

profit =

Answer 13

profit = revenue - cost

Question 13

what is the relationship between elasticity and revenue

Answer 13

Elastic demand
- Revenue increase with price decrease, vice versa

Inelastic demand
- Revenue remain the same with price increase, vice versa

Question 14

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

Answer 14

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

Question 15

Why is it important for the government to consider PED when imposing indirect tax on goods and services?

Answer 15

• less elastic = consumers are less sensitive to the increasing price of goods from taxes = more tax revenue

Question 16

changes in PED moving down the demand curve

Answer 16

• gets more positive as it moves down the demand curve (as price decrease and quantity increase)
• lower PED as it moves down the curve

Question 17

midpoint of demand curve =

Answer 17

midpoint of demand curve = unitary elastic demand

Question 18

elastic/inelastic portion of demand curve

Answer 18

• above midpoint → entire portion is elastic
• below midpoint → entire portion is inelastic

Question 19

what happens if you reduce price at the elastic portion of the demand curve

Answer 19

in elastic part → reduce price, TR will increase → responsive → % increase in Qd > % decrease in price

Question 20

what happens if you reduce price at the inelastic portion of the demand curve

Answer 20

in inelastic part → reduce price → TR will decrease → unresponsive, only changing the price