3. Elasticity of Demand: PED and YED Flashcards
What is elasticity of demand
measure of how much the demand for a product changes when there is a change in price
price elasticity of demand
measure of how much the Qd of a product changes when there is a change in P
PED
%change in Qd/ %change in P
PED (literal calculations)
((new Qd - original Qd)/original Qd) x 100/ ((new P - original P)/original P)
when PED= 0
consumer demand is not responsive to a change in price- perfectly inelastic
when PED = ∞
consumers are very responsive to a change in price- demand curve goes on forever and so Qd is infinite; if P is raised a bit demand falls to 0 (perfectly elastic)
value of something relatively inelastic (ignoring negative)
0 < PED < 1
inelastic demand
change in price leads to proportionally smaller change in Qd
revenue
price of goods and services x number of units sold
revenue box B + C
original revenue
revenue A+B
new revenue
value of something relatively elastic
1
When price increases for an inelastic product..
the quantity demanded wont fall by a lot- total revenue increases
when price decreases for an inelastic product…
the quantity demanded wont increase because customers arent responsive - total revenue decreases
elastic demand
a change in price leads to a greater than proportionate change in Qd
when price increases for an elastic product
the quantity demanded will fall by more in porportion- total revenue decreases
when price decreases for an elastic product
the quantity demanded will increase - increasing total revenue
unit elastic demand = PED= 1
when a change in P leads to a proportionate opposite change in Qd- rectangular hyperbola where revenue anywhere is constant and always has the same area
when price deceases for a unit elastic product
there is no change in total revenue
when price increases for a unit elastic product
there is no change in total revenue
Determinants for PED
SPiNTime number and closeness of Substitutes (S) Proportion of Income spent Necessity of product (N) Time period considered
substitutes as a determinant for PED
more substitutes - more elastic demand
closer the substitutes - more elastic demand
eg. different brands of butter
fewer and less alike substitutes - inelastic demand
eg. oil
necessity and how widely the product is defined as a determinant for PED
neccesity products are relatively inelastic eg. masks, food, cigs, alcohol (addictive)
HOWEVER if you define a product more specifically - meat as food demand is less inelastic as there are other alternatives
proportion of income spent on a good as a determinant for PED
if a good costs very little and constitute small part of someones budget - demand is relatively inelastic
time period considered as a determinant for PED
as P changes it takes time for consumers to change spending habits
PED more inelastic in the short term and more elastic with time as they find new products or new products come into the market
why is PED important for firms
so they can predict effects of pricing decisions on Qd thus their Total revenue
why is PED important for the government
so they know what to put taxes on - cuz when product P rises, demand might fall –> affect tax revenue
- usually place higher taxes on inelastic goods so demand wont fall significantly and lead to high unemployment
primary commodities
raw materials
manufactured products
inputs of labor and capital to create finished products
PED for primary commodities (PC)
inelastic because the “consumers” (being producers/manufacturers) have less substitutes for raw materials
if there was a decrease in P of a PC they wouldn’t want more anyways if their production targets are set already
PED for manufactured goods (MG)
elastic because more substitutes available for consumers from different producers
income elasticity of demand (YED)
measuer of how much the demand for a product changes when there is a change in consumer income
YED
%change in Qd/ %change in income
YED for normal goods
positive sign
if %increase in Qd < %increase in income..
0
if % increase in Qd> % increase in income
YED > 1 = income elastic
YED for superior goods
YED > 1 high income elasticity - as an increase in income allows people to buy more wants in greater number
YED for inferior goods
YED < 0 negative sign - as demand decreases as income increases ppl start to buy superior goods
why is YED important for firms
- so thye know which markets to enter
- products with high YED - large increase in demand as income rises so their markets will grow faster
eg. income grows in a country higher demand for smartphones - oppo, huawei, iPhone - so they know which products to produce more of
- if a country is expected to go into a recession (falling gnp) producers will want to make more inferior goods
primary sector
agricultural fishing forestry mining - primary products
secondary (manufacturing) sector
take raw materials to manufacture into producer goods
also includes construction
tertiary (service) sector
services and intangible products eg. IT, education, mass media
sectoral change
as countries and incomes grow the relative share of national output and employment changes - moving away from agriculture and towards secondary and tertiary sectors
YED in sectoral change
- demand for primary products is inelastic so when incomes grow, demand wont change that much
- extra income will be spent on income elastic goods like manufactured products
- services have high YED so output from this sector will increase as income increase
relating to sectoral change: why might living standards of a population increase
demand for tertiary products grow more rapidly as income rises and a country grows
YED for neccesities
0
