Interpreting elasticity of demand.

Question 1

What is PED?

Answer 1

How much a change in price affects demand for a product.

Question 2

What is the formula for PED?

Answer 2

PED= %change QD/ %change P

Question 3

What should be ignored when interpreting PED?

Answer 3

The minus sign can be ignored.

Question 4

What is a price elastic product?

Answer 4

A price elastic product is one where a small change in its price leads to a significant change in its demand. This means that consumers are highly sensitive to changes in the product’s price and will tend to buy less of it if the price increases, and more if the price decreases. Price elastic products are often non-essential items or have many substitutes available, such as clothing, electronics, and food items.

Question 5

What is a price inelastic product?

Answer 5

A price inelastic product is one where a change in price has little effect on the demand for the product. The demand for price inelastic products is not sensitive to changes in their price because they are considered essential items or have few substitutes available. Examples of price inelastic products include necessities such as food, medicine, and gasoline. Consumers will continue to purchase these products regardless of changes in their price because they are considered essential.

Question 6

What figure means a product is price elastic?

Answer 6

When the PED is greater than 1 (ignoring the - sign) e.g -1.5.

Question 7

What figure means a product is price inelastic?

Answer 7

When PED is less than 1 (ignoring the - sign). E.g. -0.5 is price inelastic.

Question 8

Company A rises product A’s price by 20% causing a 30% fall in demand, work out the PED.

Answer 8

PED= %change QD/ %change D

= 30%/20% = -1.5 - inelastic.

Question 9

A price reduction of product B by 20% causes a 5% increase in demand - work out the PED.

Answer 9

PED = %change in QD/ % change D
= 5/20 = -0.25 – Price inelastic.

Question 10

When is the % change in D greater than % change in price?

Answer 10

When the product is price elastic.

Question 11

When is the % change in P greater than D?

Answer 11

When the product is price inelastic.

Question 12

What factors effect price elasticity of demand?

Answer 12

The necessity of a product - some things people have to buy regardless of price; others people can buy cheaper alternatives.
- Brand loyalty
-Internet makes it easier to compare prices and find cheap alternatives for products.
- Products may be inelastic but the brand may be elastic - people have to buy fuel but may go to BP instead of Shell.
- More expensive products may be more price elastic irrespective of the brand eg. newspapers will always be less subject to demand change than cars.
- A product that a customer buys more frequently will be more price inelastic.
- New competitors - more choice.

Question 13

How do demand curves show price elasticity and inelasticity?

Answer 13

A price elastic product has a shallower demand curve. This shows that the demand is very dependent on price. A small change in demand causes a large change in demand.

A product that is inelastic has a steep demand curve as the product is not dependent on price - a large change in price won’t cause a large demand shift.

Question 14

How does a product being price elastic affect sales revenue?

Answer 14

If a product is price elastic, a price increase will make sales revenue fall as the money lost as a % from the decrease in sales will be disproportional to the %increase in price.

Question 15

100 scarves are sold for £10 each for a revenue of £1000 in Jan, where PED is -2.5.
The business increases the price by 10% in February. What will the %change in QD be? How will this change overall revenue?

Answer 15

%Change in QD = PED x % Change in price

-2.5 x 10 = -25%

They will sell 25% less in Feb; 75.

75 x 11 = £825 –> (£175 loss.)

Question 16

How can a business selling Price elastic products increase sales revenue?

Answer 16

They can marginally reduce the price to increase demand for their product to a good extent.

Question 17

How does a product being price inelastic affect revenue?

Answer 17

A rise in price will largely increase sales revenue as the cash lost due to the marginal fall in sales will be disproportionate to the cash gained from the increased output per product.

Question 18

If the scarves have a PED of -0.5 and price increases by 10%, how will the demand change?

Answer 18

-0.5% x 10 = -5% fall in demand.
100 - 5% = 95 (Amount sold)

95 x 11 (new price after 10% increase)
= £1045

Question 19

What is YED? What does it show?

Answer 19

YED or income elasticity of demand shows how demand for a product changes as incomes change.

Question 20

Why do incomes change?

Answer 20

A variety of reasons. From changing jobs to getting a promotion, a pay rise, inflation and interest rates, and general economic growth and recession.

Question 21

What is the formula for YED?

Answer 21

YED = %change in price/ % change in income.

Question 22

Incomes in the UK have risen by 20%, bringing a 5% growth in demand. What is the YED?

Answer 22

5%/20% = 0.25

Question 23

A fall in incomes by 15% brings a 10% INCREASE in demand. What is the YED?

Answer 23

10%/-15% = -0.67

Question 24

What does the income elasticity of demand depend on? What type of YED do the three relevant types of product have, what happens to them when incomes change in terms of demand?

Answer 24

What type of product it is.
Necessity products (fruit and veg) have a positive YED that is less than 1. As incomes rise, demand rises but at a slower rate than the increase in income.
- Luxury products have a positive YED, which is more than 1, meaning demand for luxury products grows faster than the increase in income.
- Inferior products are ‘cheaper products’. They have a negative YED, so demand falls when incomes rise and rises when incomes fall.

Question 25

How does elasticity help businesses with decision making? Consider how a business will price a product depending on elasticity.

Answer 25

Price elasticity helps businesses decide whether to raise or lower prices of a product. Doing so can give them a general idea about what will happen to sales and what will happen to revenue.

A price elastic product is more likely to see businesses take a competitive pricing strategy to increase sales and revenue. However, a price inelastic product would see higher prices and price skimming to increase revenue.

YED helps businesses to prepare in the case of economic fluctuations.

Question 26

What may businesses that sell multiple products do when considering PED and YED?

Answer 26

They may choose their promotion based on the economic situations. A supermarket sells a range of luxury, inferior and necessity products. Sainsbury’s may focus on promoting products of negative YED during a recession and vice versa.