3.1 - Elasticities - Price elasticity of Demand Flashcards
Price elasticity of demand
A measure of the responsiveness of the quantity demanded of a good or service to changes in its price
Price elastic demand
Quantity demanded is highly responsive
Price elasitic demand
Quantity demanded is not very responsive
Formula for PED
PED = percentage change is quantity demanded/ percentage change in price
Sign of PED
Drop the minus sign and consider it a positive number. Done to avoid confusions when making comparisons.
0<PED<1
Price inelastic demand where quantity demanded is relatively unresponsive to price. Steep downward sloping line.
1<PED<∞
Price elastic demand where quantity demanded is relatively responsive to price. Shallow downward sloping line
PED=1
Unit elastic demand where percentage change in quantity demanded equals percentage change in price. line is downward then curves and platoes.
PED=0
Perfectly inelastic demand where quantity demanded is completely unresponsive to price. Vertical line
PED = ∞
Perfectly elastic demand where quantity demanded is infinitely responsive to price. Horizontal line
Changing PED and the straight line demand curve
As we move down the curve the PED varies. When price is low and quantity is high, demand is inelastic. As we move up the curve toward higher prices and lower quantities demand becomes more and more elastic.
Why does PED vaey along a straight line curve.
PED is equal to a constant number(slope of a straight line) multiplied by P/Q. As we move down the demand curve, P gets smaller and smaller, while Q gets bigger and bigger , therefore P/Q become continuously smaller. This means that as we move down the demand curve, PED which is equal to a constant number times an ever decreasing number, must be getting smaller
How does number and closeness of subsitutes affect price elasticity of demand.
The more substitutes a good has the more elastic is its demand.
With specific brands for example if the price increases there are available substitutes to switch to so the quantity demanded changes alot.
Necessities
Goods and services we consider to be essential or necessary in our lives
Luxuries
Not necessary or essential
Necessities vs luxuries
The demand for necessities is less elastic than the demand for luxuries, people’s lives depend on them for example medication.
Length of time
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 oppurtunity to consider whether they really want and to get information on the availability of alternatives to said good
Proportion of income spend on good
The larger the proportion of one’s income needed to buy a good, the more elastic the demand
Total revenue
The amount of money recieved by a firm when they sell a good or service.
Demand is elastic, TR?
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.
Demand is inelastic, TR?
When demand is inelastic, an increase in price causes an increase in total revenue, while a decrease in price causes a fall in total revenue.
Demand is unit elastic, TR?
When demand is unit elastic, a change in price does not cause any change in total revenue.
PED and firm pricing decisions
If a business wants to increase total revenue, it must drop the price if its demand is elastic, or increase its price if demand is inelastic
PED and indirect taxes
The lower the price elasticity of demand for the taxed good, the greater the government tax revenues.
