Econ chapter 2.7 (Price elasticity of demand) Flashcards
How do you define Price Elasticity of demand?
A measure of the responsiveness of the quantity demanded to a change in price
What is the equation for PED?
PERCENTAGE CHANGE in quantity demanded
______________________________
PERCENTAGE CHANGE in price
How do you calculate percentage change in price?
Change in price
___________ x 100
Original price
How do you calculate percentage change in QD?
Change in Qd
___________ x 100
Original Qd
What does an elastic PED graph look like?
often drawn as a flattish curve to illustrate how the % change in Qd is much larger than % change in price
What does a PED value less than 1 show?
It shows that it is inelastic - the %change in Qd is smaller than change in price so (small number)/(larger number) results in a decimal
What does a PED value = 1 suggest?
unit elasticity- percentage change of quantity demanded is the same as the % change in price.
What does a PED value greater than 1 suggest?
PED is elastic- the %change of Qd is larger than % change in Price (larger number)/(smaller number)= greater than one
How is inelastic PED shown on a graph?
the curve is drawn steep to show that Qd does not change as much as price
Why is the sign of any PED value going to be negative?
due to the inverse relationship between price and quantity demanded, as described by the law of demand.
e.g For example, a 10% increase in price might lead to a 5% decrease in quantity demanded, yielding a PED of -0.5.
(the absolute value is typically used however.)
Define elastic demand
When the quantity demanded changes by a greater percentage than the change in price.
define inelastic demand
When the quantity demanded changes by a smaller percentage than the change in price.
Define total revenue
Total Revenue (TR) is the total amount of money a firm receives from selling its goods or services. It’s calculated by multiplying the price per unit by the quantity sold.
What are the determinants of PED
Availability of Substitutes
Proportion of Income
Necessity vs. Luxury
Time Period
Addictiveness
What happens when there are few substitues for a good or service?
demand will be inelastic- if the price of a good with few substitutes increases, consumers can’t switch to other substitute products, therefore causing a relatively small drop in Qd
e.g insulin
What happens when the good has a close substitute or has many?
elastic demand- a rise in price will likely cause a significant fall in the Qd as consumers will switch to the substitute
What happens when the good is addictive?
Demand is inelastic- people find it difficult to cut back on their purchases of products which are addictive
e.g cigarettes, coffee
What is the number of substitutes determined by
how broadly the good is defined- for example, there are not many substitutes for ‘fruits’ making it’s PED inelastic compared to a more narrowly defined ‘apples’ which has many substitues
The more substitutes a good has the more ________ its demand is
elastic
What does it mean for elasticity if the good is a necessity?
necessity- a good/service we consider to be essential or necessary in our lives
The demand is usually inelastic - peoples lives and health depend on these things
e.g food, medication, masks
What does it mean for elasticity if the good is a luxury?
the demand is usually elastic
e.g demand for diamonds tends to be very elastic as people do not rely on it for survival
What does it mean for elasticity if the good is worth a low proportion of income?
inelastic demand-
e.g salt takes up a small percentage of income- a 5% increase in price should result in only a small fall in demand.
the lower the proportion of one’s income needed to buy a good, the more _________ the demand
inelastic
What does it mean for elasticity if the good is worth a high proportion of income?
demand is elastic
e.g big screen tvs take up a large proportion of income- a 5% increase in price should result in a greater contraction in demand.
How does the time frame affect the price elasticity of demand in the short run?
In the short run, demand is generally more inelastic because consumers need time to adjust their behaviour. They may continue purchasing a good out of habit or due to a lack of immediate alternative, or because they haven’t noticed a price change.
How does the time frame affect the price elasticity of demand in the long run?
In the long run, demand becomes more elastic as consumers have sufficient time to find substitutes, adjust their consumption habits, or make lifestyle changes in response to price changes
How do contracts/ autopay affect price elasticity of demand?
Contracts make demand more inelastic since consumers are locked into agreements and cannot easily switch, even if prices chang
How does closeness of substitutes affect price elasticity of demand?
More close substitutes make demand elastic, as consumers can easily switch if the price rises. Few substitutes make demand inelastic.
How does availability of substitutes impact price elasticity?
If substitutes are readily available, demand is elastic. If they are scarce or unavailable, demand is inelastic.
What is revenue
the money a firm makes from sales (not the same thing as profit -revenue-costs- )
How is total revenue shown on a graph?
as a rectangle on a demand diagram (area of rectangle= base x height)
In what ways is revenue impacted by a fall in price?
more quantity sold (more revenue)
at a lower price (less revenue)
We can deduce the degree of loss and gain with PED.
In what ways is revenue impacted by a fall in price?
less quantity sold (less revenue)
at a higher price (more revenue)
We can deduce the degree of loss and gain with PED.
What will a fall in price do to revenue of the demand is ELASTIC?
The gain due to greater Qd / quantity sold > loss due to fall in price
Total revenue increases
What will a fall in price do to revenue of the demand is INELASTIC?
loss due to fall in price>The gain due to greater Qd / quantity sold
Total revenue decreases-
What will increase in price do to revenue if demand is ELASTIC?
Loss due to less Qd/quantity sold> Gain due to increase in p
Total revenue decreases
What will increase in price do to revenue if demand is INELASTIC?
Gain due to increase in p> Loss due to less Qd/quantity sold
Total revenue increases
If the firm wishes to maximise their revenue, they should increase the price if demand is_______ and _________ the price if demand is elastic
inelastic
lower
Why is PED important for firms?
helps firms maximise revenue. Firms know that if demand is elastic they should lower prices- if demand is inelastic they should increase prices.
Why is PED important for governments?
Helps them understand the impact of taxes- indirect taxes on goods with ELASTIC demand will cause a big fall in quantity sold.
Taxes on goods with INELASTIC demand will cause only a small fall in quantity sold
if a govt wants to raise tax revenue, they should place taxes on goods which have inelastic demand.
Why is PED important for consumers?
They should be aware that if they buy a good/service which has inelastic demand, they are more likely to be affected by high prices and poor quality.
What should u be careful of when talking about PED
you dont say that the good/service is inelastic/elastic you say the demand for it is elastic/inelastic
