Chapter 11: Price Elasticity of Demand Flashcards
Price elasticity of demand
A measure of the responsiveness of the quantity demanded to a change in price.
PED = Percentage change in quantity demanded / Percentage change in price
Interpretation of PED
The PED figure provides two pieces of information. One is given by the sign. In the vast majority of cases, it is a minus. This tell us that there is an inverse relationship between the quantity demanded and price – a rise in price will cause a contraction in demand and a fall in price will cause an extension in demand.
PED >1 elastic
PED = 1 unitary elasticity
PED <1 inelastic
PED = 0 perfectly inelastic
PED = infinity perfect elastic
Determinants of PED
- Proportion of income taken up by product
- Time
- Closeness and availability of substitutes
- Necessity/luxury,
- Addictiveness/habit forming,
- Degree of brand loyalt
- How narrowly defined the market is
Total revenue
p x q
represented as a rectangle under demand curve
How the impact of a change in price on TR depends on PED
If D is elastic, an increase in price causes a fall in TR
If D is inelastic, an increase in price causes a rise in TR
Perfectly elastic demand
When a change in price causes a complete change in the quantity demanded.
Perfectly inelastic demand
When a change in price has no effect on the quantity demanded.
Unit elasticity of demand
When a change in price causes an equal change in the quantity demanded, leaving total revenue unchanged.
Varying PED along demand curve
PED becomes more elastic as the price of a product rises. Consumers become more sensitive to price changes, the higher the price of the product. As the price falls, demand becomes more inelastic.
Implications of PED for decision making
Producers – use PED to predict impact of pricing changes
Governments – use PED to predict impact of taxes and subsidies
