elacticity Flashcards
What is price elasticity of demand (PED)?
PED
Price elasticity of demand (PED) measures how much the quantity demanded of a good responds to a change in its price. It is defined as the percentage change in quantity demanded divided by the percentage change in price.
If PED > 1, the demand is elastic (consumers are very responsive to price changes).
If PED < 1, the demand is inelastic (consumers are not very responsive to price changes).
If PED = 1, the demand is unitary elastic (percentage change in quantity demanded equals the percentage change in price).
Formula:
%
ChangeinQuantityDemanded
%
ChangeinPrice
PED=
%ChangeinPrice
%ChangeinQuantityDemanded
What factors affect the price elasticity of demand?
vailability of Substitutes: If there are close substitutes for a product, demand is likely to be more elastic.
Example: If the price of Coca-Cola rises, consumers can easily switch to Pepsi, making the demand for Coca-Cola elastic.
Necessity vs. Luxury: Necessities tend to have inelastic demand, while luxury goods have more elastic demand.
Example: The demand for insulin (a necessity) is inelastic, while the demand for high-end watches (a luxury) is elastic.
Proportion of Income Spent: If a good represents a large portion of a consumer’s income, the demand tends to be more elastic.
Example: A large increase in the price of cars may significantly reduce demand because cars are a major expenditure for most people.
What is price elasticity of supply (PES)?
PES
Price elasticity of supply (PES) measures how much the quantity supplied of a good responds to a change in its price. It is calculated as the percentage change in quantity supplied divided by the percentage change in price.
If PES > 1, the supply is elastic (producers are very responsive to price changes).
If PES < 1, the supply is inelastic (producers are not very responsive to price changes).
If PES = 1, the supply is unitary elastic (percentage change in quantity supplied equals the percentage change in price).
Formula:
%
ChangeinQuantitySupplied
%
ChangeinPrice
PES=
%ChangeinPrice
%ChangeinQuantitySupplied
What is income elasticity of demand (YED)?
YED
Income elasticity of demand (YED) measures how the quantity demanded of a good changes in response to a change in income. It is calculated as the percentage change in quantity demanded divided by the percentage change in income.
If YED > 1, the good is a luxury good (demand increases more than income).
If YED < 1, the good is a necessity (demand increases less than income).
If YED = 0, the good is income-inelastic (demand does not change with income).
If YED < 0, the good is an inferior good (demand decreases as income increases).
Formula:
%
ChangeinQuantityDemanded
%
ChangeinIncome
YED=
%ChangeinIncome
%ChangeinQuantityDemanded
How can understanding elasticity help businesses?
Understanding elasticity helps businesses make informed decisions regarding pricing strategies, product offerings, and marketing efforts. For instance:
If demand for a product is elastic, a company may lower prices to increase total revenue.
If demand is inelastic, a company can raise prices without significantly reducing sales, increasing total revenue.
Elasticity also helps businesses determine which products to prioritize, and how sensitive consumers are to price changes, which is important in competitive and dynamic markets.
