3.1 Price elasticity of demand (PED) Flashcards
What is the law of demand
- as price increases, quantity demanded decreases
- as price decreases, quantity demanded increases
*ceteris paribus
What does PED stand for
price elasticity of demand
What does PED measure
a measure of the responsiveness of the quantity demanded of a good to a change in price
What is the formula for PED
PED = % change in QD/% change in price
Is PED always positive or negative
positive
why is elasticity measured in percentage changes
- we need a measure of responsiveness that is independent of units
e.g. currencies around the world - percentages allow us to put responsiveness into perspective
e.g. 2% increase of $100 and $5000
What does price inelastic mean
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
what does price elastic mean
PED > 1
- quantity demanded is highly responsive to changes in prices
- the percentage change in quantity demanded is greater than the change in price
what does unit elastic mean
PED = 1
- the percentage change in quantity demanded is equal to the percentage change in price
what does perfectly inelastic mean
PED = 0
- quantity demanded is unresponsive to changes in price
what does perfectly elastic mean
PED = infinity
- change in price results in an infinitely large response in quantity demanded
what does the steepness of a curve that intersects tell us
steeper = inelastic
flatter = elastic
PED for goods with substitutes
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
PED for goods with no substitutes
inelastic = PED < 1
- quantity demanded remains relatively unresponsive to an increase in price because there are no alternatives/substitutes
PED of a good that is narrowly defined
elastic = PED > 1
- the more narrowly defined, the more substitutes are available
e.g. apples, pears
PED of a good that is broadly defined
inelastic = PED < 1
- if something is broadly defined there are no substitutes
e.g. fruit
PED of necessities
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
PED of luxuries
elastic = PED > 1
- luxuries are not necessary and therefore quantity demanded is highly responsive to price changes
e.g. jewellery
what are some highly inelastic goods
goods that are addictive e.g. cigarettes, alcohol
- increase in price will lead to only a small decrease in the quantity demanded
what is a perfectly inelastic good
life-changing medicine with no substitutes as quantity demanded will remain unresponsive to price changes
what does a longer time period mean for PED
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
what does a shorter time period mean for PED
immediately following a price increase, consumers are not able to alter their consumption patterns, therefore the good is inelastic
PED if the good takes up a large portion of income
elastic:
consumers will notice that there are price changes and quantity demanded will respond by a greater amount
e.g. car
PED if the good takes up a small portion of income
inelastic:
consumers are less concerned about the price changes and quantity demanded stays the same
e.g. toothpicks
Define “total revenue”
total amount received by firms when selling a good or service = price x quantity
What will happen to total revenue when demand is elastic (PED > 1)
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
What will happen to total revenue when demand is inelastic (PED < 1)
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
What will happen to revenue when demand is unit elastic (PED=1)
a change in price does not cause any change in total revenue
What are primary commodities
goods arising directly from the use of natural resources (land), therefore agricultural products
What are manufactured products
goods produced by factors of production such as labour and capital
Why do most primary commodities have a price inelastic demand
- they are necessities
- consumers need them regardless of changes in price
- quantity demanded is highly unresponsive to price changes - fewer/to no substitutes
Why do most manufactured products have a high price elastic demand
usually have substitutes
Why do government need to intervene in agricultural sectors
frequent supply changes and large fluctuations in price due to factors out of their control can lead to unstable farmer revenues
consequences of a low PED for primary commodities
- 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
what is price volatility
large price fluctuations over short periods of time
how to farmers earn revenue
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.
Is supply of agricultural products stable
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
