3.1 Price elasticity of demand (PED)

Question 1

What is the law of demand

Answer 1

• as price increases, quantity demanded decreases
• as price decreases, quantity demanded increases
  *ceteris paribus

Question 2

What does PED stand for

Answer 2

price elasticity of demand

Question 3

What does PED measure

Answer 3

a measure of the responsiveness of the quantity demanded of a good to a change in price

Question 4

What is the formula for PED

Answer 4

PED = % change in QD/% change in price

Question 5

Is PED always positive or negative

Answer 5

positive

Question 6

why is elasticity measured in percentage changes

Answer 6

1. we need a measure of responsiveness that is independent of units
   e.g. currencies around the world
2. percentages allow us to put responsiveness into perspective
   e.g. 2% increase of $100 and $5000

Question 7

What does price inelastic mean

Answer 7

PED < 1

• quantity demanded is relatively unresponsive to changes in price
• the percentage change in quantity demanded is smaller than the percentage change in price

Question 8

what does price elastic mean

Answer 8

PED > 1

• quantity demanded is highly responsive to changes in prices
• the percentage change in quantity demanded is greater than the change in price

Question 9

what does unit elastic mean

Answer 9

PED = 1

• the percentage change in quantity demanded is equal to the percentage change in price

Question 10

what does perfectly inelastic mean

Answer 10

PED = 0

• quantity demanded is unresponsive to changes in price

Question 11

what does perfectly elastic mean

Answer 11

PED = infinity

• change in price results in an infinitely large response in quantity demanded

Question 12

what does the steepness of a curve that intersects tell us

Answer 12

steeper = inelastic
flatter = elastic

Question 13

PED for goods with substitutes

Answer 13

elastic = PED > 1

• quantity demanded is highly responsive to an increase in price if the good has substitutes as they can easily switch to another product
  *greater responsiveness to close substitutes with greater substitutability, able to easily switch

Question 14

PED for goods with no substitutes

Answer 14

inelastic = PED < 1

• quantity demanded remains relatively unresponsive to an increase in price because there are no alternatives/substitutes

Question 15

PED of a good that is narrowly defined

Answer 15

elastic = PED > 1

• the more narrowly defined, the more substitutes are available
  e.g. apples, pears

Question 16

PED of a good that is broadly defined

Answer 16

inelastic = PED < 1

• if something is broadly defined there are no substitutes
  e.g. fruit

Question 17

PED of necessities

Answer 17

inelastic = PED < 1

• necessities are considered to be essential in our lives, something we cannot live without. Therefore, the quantity demanded is highly unresponsive to price changes
  e.g. food

Question 18

PED of luxuries

Answer 18

elastic = PED > 1

• luxuries are not necessary and therefore quantity demanded is highly responsive to price changes
  e.g. jewellery

Question 19

what are some highly inelastic goods

Answer 19

goods that are addictive e.g. cigarettes, alcohol

• increase in price will lead to only a small decrease in the quantity demanded

Question 20

what is a perfectly inelastic good

Answer 20

life-changing medicine with no substitutes as quantity demanded will remain unresponsive to price changes

Question 21

what does a longer time period mean for PED

Answer 21

becomes more elastic as consumers have the chance to adjust their behaviour by finding substitutes and changing consumption patterns
e.g. adjusting behaviour by driving electric cars, catching public transport

Question 22

what does a shorter time period mean for PED

Answer 22

immediately following a price increase, consumers are not able to alter their consumption patterns, therefore the good is inelastic

Question 23

PED if the good takes up a large portion of income

Answer 23

elastic:
consumers will notice that there are price changes and quantity demanded will respond by a greater amount
e.g. car

Question 24

PED if the good takes up a small portion of income

Answer 24

inelastic:
consumers are less concerned about the price changes and quantity demanded stays the same
e.g. toothpicks

Question 25

Define "total revenue"

Answer 25

total amount received by firms when selling a good or service = price x quantity

Question 26

What will happen to total revenue when demand is elastic (PED > 1)

Answer 26

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

Question 27

What will happen to total revenue when demand is inelastic (PED < 1)

Answer 27

when demand is inelastic, an increase in price causes a rise in total revenue, while a decrease in price causes a fall in total revenue

Question 28

What will happen to revenue when demand is unit elastic (PED=1)

Answer 28

a change in price does not cause any change in total revenue

Question 29

What are primary commodities

Answer 29

goods arising directly from the use of natural resources (land), therefore agricultural products

Question 30

What are manufactured products

Answer 30

goods produced by factors of production such as labour and capital

Question 31

Why do most primary commodities have a price inelastic demand

Answer 31

1. they are necessities - consumers need them regardless of changes in price - quantity demanded is highly unresponsive to price changes 2. fewer/to no substitutes

Question 32

Why do most manufactured products have a high price elastic demand

Answer 32

usually have substitutes

Question 33

Why do government need to intervene in agricultural sectors

Answer 33

frequent supply changes and large fluctuations in price due to factors out of their control can lead to unstable farmer revenues

Question 34

consequences of a low PED for primary commodities

Answer 34

- agricultural products experience fluctuations in supply over short periods of time - these price fluctuations are much greater when demand is inelastic - primary commodities can be highly volatile

Question 35

what is price volatility

Answer 35

large price fluctuations over short periods of time

Question 36

how to farmers earn revenue

Answer 36

poor crop = less supply = higher prices - therefore there will be an increase in revenue as the quantity demanded doesn't decrease as much due to an increase in price good crop = more supply = lower prices - therefore there sill be a decrease in revenue as quantity demanded doesn't increase much due to a decrease in price therefore, ironic conclusion that poor crop may be beneficial for farmers.

Question 37

Is supply of agricultural products stable

Answer 37

no, because production relies on many factors beyond a farmer's control such as natural disasters and weather conditions, which occur over short periods of time - therefore this causes frequent supply changes (supply shifts) and large fluctuations in price for inelastic goods