Chapter 7: Elasticity of Demand

Question 1

What is PED?

Answer 1

Responsiveness of how qd changes owing to factor that affects demand.

Question 2

What is price elastic demand?

Answer 2

When demand is relatively responsive to changes in price.
close substitutes being widely available.
consumers more responsive/sensitive.
PED >1

Question 3

What is price inelastic demand?

Answer 3

Demand is relatively unresponsive to changes in price, consumers unable to react swiftly.
PED < 1

Question 4

What is formula of PED?

Answer 4

% change in qd / % change in price

Question 5

Is the ‘operator’ of PED important?

Answer 5

Math value is negative due to law of demand
Conventional to ignore when interpreting value.
Value depends on degree of ability/willingness to continue buying if $ changes

Question 6

What are the determinants of PED? (TINS)

Answer 6

1)Time
2) No. + closeness of substitutes
3) Degree of necessity
4) Proportion of income spent?

Question 7

How does time determine PED?

Answer 7

1) over time, PED is more elastic, more time to find alts.
2) more time to change habits/prefers.
3) with time, higher prices can cause consumers to change decision once more.

Question 8

Why does a durable product have a more elastic demand?

Answer 8

No urgency to replace, even if prices increase.

Question 9

How does no. + closeness of substitutes determine PED?

Answer 9

1) Greater availability, higher PED, easily able to switch to diff alt if small change.
2) Less availability, inelastic, not much choice.

Question 10

How can firms attempt to increase the opportunity cost of switching to an alternative brand??

Answer 10

if there are high costs involved to switch, demand will be inelastic. If there are lengthy contracts/loyalty programmes, opportunity cost is increased, more difficult to switch.

Question 11

How does degree of necessity determine PED?

Answer 11

1) essential goods, tend to be inelastic, relatively unresponsive.
2) Luxury, relatively elastic, as can choose alts.

Question 12

Why does degree of necessity depend on what is deemed by individuals?

Answer 12

3) if addictive, fashionable or essential it is inelastic.
4) they have little choice but to pay market price.

Question 13

How does proportion of income spent determine PED?

Answer 13

1) greater proportion of real disposable income spent, more price elastic, ceteris paribus.
2) buyers more sensitive to changes in price, as it accounts for > proportion
3) if proportion is small, has minimal impact.

Question 14

What is the relationship between PED and Total revenue?

Answer 14

1) Value of PED shows changes in firm’s revenue due to price changes.
2) Firms with price inelastic demand can increase price to earn more.
3) Firm with elastic demand can earn more revenue if price decreased.
4) changing prices means more net gain in TR.
5) Gain in TR will be bigger than loss.

Question 15

What are the degrees of PED?

Answer 15

1) Perfectly price inelastic =0
2) Unitary elastic demand = 1
3) Perfectly price elastic = infinity

Question 16

What is perfectly price inelastic demand?

Answer 16

PED = 0, change in price has no impact on qd.
Suggest there are no substitutes

Question 17

What is perfectly price elastic demand?

Answer 17

1) PED = infinite, demand exists at one point only, changes lead to zero demand, customers will switch to buying other subs readily available if price increase.
2) Only exists if there are perfect substitutes, leads to infinite change in qd.

Question 18

What is unitary price elastic demand?

Answer 18

1) PED = 1.0, change in price leads to same % change of qd.
2) Total spending remains same at all given prices.
3) no change to firm sales revenue

Question 19

What happens to PED when going along a straight line downward sloping demand curve?

Answer 19

1) Value of PED goes up going up demand curve, occurs as customers are more responsive.
2) PED = 1 at midpoint, equilibrium, prices above point, PED >1.
3) If $ accounts for most of income demand = 0, PED = infinite.
4) Below eq, PED < 1
5) less sensitive to change, smaller of household income.

Question 20

What is the importance of PED to for firms?

Answer 20

1) informs firms about effect change of price has on sales revenue (p x q)
2) allows to assess impact of changing price on qd and sales.

Question 21

What is price discrimination and how is it used by firms?

Answer 21

1) When given diff PED values, price discrimination used to charge diff consumers diff price.
2) E.g adult tickets and child tickets, discounts to elderly etc.

Question 22

What are surge/dynamic pricing?

Answer 22

1) Hiking prices depending on time of year, e.g airlines increasing prices during holiday seasons,
2) charge increased price when demand is inelastic.

Question 23

How do governments use PED?

Answer 23

1) to determine taxation policies.
2) E.g demerit goods (alcohol cigs, etc) are inelastic.
3) tax needs to be high to minimise consumption, generates more tax
4) consumers pay most of burden, producers pay remainder, combined area shows tax rev collected by gov.
5) increase does little to reduce, informs govs that actions don’t effect cig manufacturers jobs.

Question 24

Why is PED for primary commodities lower than manufactured products?

Answer 24

1) lack substitiutes
2) essential for production, relatively inelastic
3) proportion of income is low, accounts for small proportion of production costs.
4) time needed to harvest goods is larger than manufacturing, less time taken, lower value of PED

Question 25

Why is demand for manufactured products relatively price elastic?

Answer 25

1) Most manufactured products, many substitutes
2) Degree of necessity lower
3) Takes up larger proportion of income
4) Can be used continuously over long period of time, tends to be higher PED value.