Elasticity Of Demand Flashcards
Elasticity : definition
A measure of the extent to which quantity demanded responds to a change in a variable that affects it such as price or income.
What does PED measure ?
How responsive the quantity demanded is to change in price. Ie how important price is in determining wether or not consumers buy a product.
PED : formula
% change in quantity demanded / % change in price
Elastic : summary
If PED > 1 demand is said to be elastic
PED is elastic when customers are sensitive to changes in price ie a small % change in price will lead to a relatively large % change in quantity demanded.
What type of goods are likely to have highly price elastic demand . :
Products that are widely available
Many substitutes available.
Inelastic : summary
If PED is between 0 and 1 demand is said to be inelastic.
PED is inelastic when customers are not sensitive to changes in price ie a large % change in price causes only a small % change in quantity demand.
Inelastic goods : examples
Highly branded Innovative Short supply Few substitutes Habit forming Necessities
Factors that determine PED :
The degree of necessity ie product bought even if price increases (inelastic).
Addictive ness of product ie product bought even if price increases (inelastic).
Availability of substitutes ie customer will switch to substitutes when price increases (elastic).
% of income spent on the product ie if it is a low % income, customers are unlikely to notice large % increase in price (elastic).
Period of time over which elasticity is measures ie if price of oil was to rise in winter people would still buy but if it stayed high through summer demand will become elastic.
Brand loyalty ie customer not likely to be put off by prices rising (inelastic)
If a firm knows that the demand for its product is inelastic, what should it do to its price ?
Is crease price because revenue from price rise for inelastic products will be higher than that of a price decrease.
If the opposite happened
If price for inelastic good is lowered the demand for good doesn’t unscrewed by a lot ie resulting in less overall revenue due to lower price and no real change in demand eg salt, basic food.
If a firm knows that the demand for its product is elastic, what should it do to it’d price ?
Lower price because a small decrease in price leads to greater % increase in quantity demanded.
Opposite direction
Small increase in price would lead to a large fall in quantity demanded. This would lead to a reduction in total revenue.
Rule when PED is elastic :
When price increases and quantity demanded decreases then revenue decreases.
When price decreases and quantity demanded increase then revenue increases.
Rule when PED is inelastic :
When price increases and quantity demanded decreases then the revenue increases.
When price decreases and quantity demanded increases then the revenue decreases.
How a firm might make demand for its products more inelastic :
Increase branding and marketing
Differentiate
Take over competition
Make price changes over short period of time
Income elasticity of demand (YED) : definition
Income is an important determinant of consumer demand, YED shows precisely the extent to which changes in income lead to changes in demand.
YED : equation
% change in quantity demanded / % change in income
