2.5 Price Elasticity of Demand (PED)

Question 1

elasticity

Answer 1

A measure of the RESPONSIVENESS of an economic variable, such as the quantity demanded of a good or service, to a change in another economic variable, like price or income.

• important note: you cannot say that a good is inelastic or elastic as it is the demand between two points on a demand curve that is relatively elastic or inelastic.

Question 2

price elasticity of demand

Answer 2

Price Elasticity of Demand (PED) measures the responsiveness of the quantity demanded of a particular good or service to a 1% change in its price, ceteris paribus.

PED represents
a ratio of the change in the quantity demanded and the percentage change in price of a particular good. Summarised by the following formula:
|PED|= % change in Qd of good A / % change in P of good A

E.g: A PED of -2 would mean that for every price increase of 1%, the quantity demanded would fall by 2%.

Question 3

total revenues

Answer 3

Total revenue is the total income a firm receives from selling its goods or services in a given time period. It is calculated as the price of the good multiplied by the quantity sold.

TotalRevenue(TR)=Price(P)×Quantity(Q)

Question 4

price inelastic demand

Answer 4

Price inelastic demand occurs when the quantity demanded of a good or service changes by a smaller percentage than the change in price. This means that the price elasticity of demand (PED) is less than 1 (|PED| < 1), and the % change of price > % change of quantity demanded. In essence, this means that price inelastic demand is LESS responsive to price changes.

Goods with inelastic demand are often necessities or have few substitutes, so consumers are less responsive to price changes.

Question 5

price elastic demand

Answer 5

When the percentage change in the quantity demanded of a good is greater than the percentage change in its price. Goods with price elastic demand have a price elasticity of demand (PED) greater than 1. In essence, this means that price elastic demand is MORE responsive to price changes.

Luxury goods often have elastic demand because consumers can reduce their purchases significantly when prices rise.

Question 6

perfectly price inelastic demand

Answer 6

When the quantity demanded of a good or service remains constant, regardless of changes in its price. Represented by a vertical demand curve, perfectly price inelastic demand has a PED=0, indicating that consumers will buy the same amount even if the price increases or decreases.

Applies to highly addictive goods or essential goods (drugs, medicine).

Question 7

perfectly price elastic demand

Answer 7

When the quantity demanded responds infinitely to any change in price, meaning consumers will only purchase the good at one exact price. If the price changes even slightly, demand drops to zero. Perfectly price elastic demand is represented by a horizontal demand curve at a specific price level. In this case, PED is equal to infinity.

Applies to perfect/very close substitutes.

Question 8

unit price elastic demand

Answer 8

When the percentage change in quantity demanded of a good is exactly equal to the percentage change in its price. This results in no change to total revenue when the price changes. In this case, PED = 1, indicating that demand is perfectly balanced to changes in price. The demand curve is known as a rectangular hyperbola.

Question 9

substitute

Answer 9

products that can be used in place of one another because they fulfil similar needs or wants. When the price of one substitute good increases, the demand for the other substitute good typically increases as well, indicating a direct relationship between the two. (e.g. margarine and butter)

Question 10

the determinants of PED

Answer 10

SHIT
* Substitutes: the number of substitutes and the closeness of available substitutes
* Habit: the degree of necessity of a good, including brand loyalty and addiction
* Income: the proportion of income spent on the good
* Time: time to respond to a change in price

Question 11

formula for price change (in quantity demand or price)

Answer 11

(N - O / O) x 100

Question 12

How do substitutes effect PED?

Answer 12

The more substitutes a good has, the easier it is for consumers to switch to another good when the price of that good goes up and the more price elastic demand will be. This means that the value of PED increases.

If there is a perfect substitute, the PED will be infinity. This means that the smallest increase in price of good X will lead to a total switch of the quantity demanded to its perfect substitute and quantity demanded of good X will fall to zero.

Question 13

How do habits effect PED?

Answer 13

The stronger the brand or the more necessary or addictive a good is, the more price inelastic demand.

Question 14

How does time effect PED?

Answer 14

The longer consumers have to change their behaviour the more likely it is they will respond to a change in price and the more price elastic demand. Price elasticity of demand is greater in the long run than in the short run.

Question 15

How does income effect PED?

Answer 15

The lower the proportion of income spent on a good, the more price inelastic demand.

Question 16

perfect substitute (not in glossary)

Answer 16

A perfect substitute is a good or service that can be used in place of another to satisfy the same need or want, with no loss in utility or satisfaction for the consumer.

Question 17

Producer subsidy

Answer 17

a grant paid by the government to a firm, per unit of output, to encourage production and lower the price to consumers.

Question 18

indirect taxes

Answer 18

payments to the government (taxes) on the spending on goods and services, included in the selling price or added to the selling price.

Question 19

How does the value of PED impact TR when the selling price of a good changes?

Answer 19

Elastic Demand (PED > 1): With elastic demand, price and total revenue move in opposite directions. If price increases, total revenue decreases because the large drop in quantity demanded outweighs the price increase. If price decreases, total revenue increases because the large rise in quantity demanded outweighs the price decrease.

Inelastic Demand (PED < 1): With inelastic demand, price and total revenue move in the same direction. If price increases, total revenue increases because the small drop in quantity demanded is outweighed by the higher price. If price decreases, total revenue decreases because the small rise in quantity demanded is outweighed by the lower price.

Unit Elastic Demand (PED = 1): When demand is unit elastic, any change in price results in a proportional change in quantity demanded, so TR remains unchanged.