Micro 5 - Price elasticity of demand Flashcards
Define Price Elasticity of Demand
Price elasticity of demand is a measure of how the quantity demanded of a good responds to a change in its price
What is the formula for calculating PED?
Percentage change in quantity demanded / percentage change in price
Is PED a percentage?
No
Why is price elasticity of demand usually negative?
Price elasticity of demand is usually negative because demand falls as price increases for most goods.
Therefore it is usually a negative figure divided by a positive figure.
What are the 3 different categories that PED can be?
- Elastic
- Inelastic
- Unit Elastic
What does the PED value have to be for a product to have relatively elastic demand?
Greater than 1
What does a PED value of greater than 1 for a product mean?
It has relatively price elastic demand
What does relatively price elastic demand mean?
A percentage change in price will cause a larger percentage change in quantity demanded
The higher the the value of PED the …
more elastic demand is for a good
What does a PED of ± infinity for a product mean?
It is has perfectly price elastic demand
What does the PED value for a product with perfectly price elastic demand have to be?
± infinity
What does perfectly price elastic demand mean?
Any increase in price of a product means that demand for the product will fall to zero
What does the PED value have to be for a product with relatively price inelastic demand?
Between 0 and 1
What does a PED value of between 0 and 1 mean for a product?
It has relatively price inelastic demand
What does relatively price inelastic demand mean?
The percentage change in price will cause a smaller percentage in quantity demanded
The smaller the PED value the …
more inelastic demand is
What does the PED value have to be for a product for it to have perfectly price inelastic demand?
0
What does a PED of 0 mean for a product?
It has perfectly price inelastic demand
What does perfectly price inelastic demand mean?
Any change in price will have no effect on the quantity demanded. At any price the quantity demanded will be the same
What does the PED value have to be for a product for it to have unitary price elasticity of demand?
±1
What does a PED value of ±1 mean?
Unitary price elasticity of demand
What does unitary price elasticity of demand mean?
The percentage change in price is equal to the percentage change in quantity demanded
How many factors affect the Price Elasticity of Demand?
4
What are the factors which affect Price Elasticity of Demand?
- Substitutes
- Type of good or service (How essential it is)
- Proportion of income spent on good
- Time
How does substitutes affect PED?
The more available substitutes a good has the more price elastic demand it is. If there are many substitutes available then consumers can easily switch to something else if the price rises.
The number of substitutes a good has depends on how closely it is defined.
How does the type of good or service affect PED?
- Demand for essential items is price inelastic but demand for non-essential items tends to be price elastic
- Demand for goods that are habit-forming tends to price inelastic
- Demand for purchases that cannot be postponed tends to price inelastic
- Demand for products with several different uses tends to be price inelastic
How does the percentage of income spent on a good affect PED?
Demand for products that need a large proportion of the consumer’s income is more price elastic than demand for products that only need a small proportion of income. Consumers are more likely to shop around for the best price for an expensive good
How does time affect the PED?
In the long run demand becomes more price elastic as it becomes easier to change to alternatives because consumers have had the time to shop around. Also in the long run habits and loyalties can change
What will the demand curve for relatively price elastic demand look like?
Relatively flat
What will the demand curve for perfectly price elastic demand look like?
Horizontal
What will the demand curve for relatively price inelastic demand look like?
Relatively steep
What will the demand curve for perfectly price inelastic demand look like?
Vertical
How does price elasticity of demand change along a straight-line demand curve?
PED changes along the demand curve from minus infinity at high price/zero demand through to an elasticity of minus one at the midpoint to an elasticity of zero at zero price/high quantity demanded.
At which PED is total revenue maximised?
±1
- The nearer a firm sets a product’s price to the mid-point of the demand curve the higher its total revenue will be
If a good has elastic demand what effect will a reduction in price have on the firm’s total revenue?
A reduction in price will increase the firm’s total revenue
If a good has elastic demand what effect will an increase in price have on the firm’s total revenue?
An increase in price will reduce the firm’s total revenue
If a good has inelastic demand what effect will a reduction in price have on the firm’s total revenue?
A reduction in price will reduce the firm’s total revenue
If a good has inelastic demand what effect will an increase in price have on the firms total revenue?
An increase in price will increase the firm’s total revenue
