Pack 5 Flashcards
Explain price elastic and inelastic demand using numerical examples.
PED measures the responsiveness of the QD for a good/service to a change in its price.
If a product has inelastic demand, customer demand is not very responsive to changes in price. So if prices rose by 10%, demand will fall but it will fall by less than the 10% price rise (% change in demand will be less than the % change in price).
If a product has PED, demand is responsive to changes in price. If prices rise by 10%, demand will fall by more than 10% (% change in demand will be greater than % change in price).
Explain the 4 key factors which affect PED
Availability of substitutes - the fewer alternatives a good has, the more price inelastic demand for that product will be.
Time period - takes time for people to realise and respond to changes. In the short term they will be loyal to the current firm despite a cheaper alternative because they haven’t found out about it yet.
Proportion of income - the smaller and more frequent the purchase, the more likely it will have price inelastic demand. It is still affordable after a price rise.
Necessities - we are prepared to pay any price for products we need like food and vital medicine so demand will be price inelastic. Some people might form habits like smoking which makes cigarettes a necessity for them which tend to be price inelastic demand due to addiction.
Formula for PED
% change in QD / % change in price
What does a PED of -1 mean
Unitary price elasticity of demand:
% changes in price will be equal to % changes in QD. A 10% increase in price will lead to a 10% decrease in sales.
What does a PED of 0 mean
Perfectly price inelastic demand:
Demand is completely unresponsive to any change in price.
What does a PED of -2 mean
Relatively price elastic demand:
The % changes in price will be smaller than the % changes in QD. A 10% decrease in price would lead to a 20% increase in sales
What does a PED of -0.2 mean
Relatively price inelastic demand:
The % change in price will be larger than the % change in QD. A 1% increase in price would lead to a 0.2% decrease in sales.
How might PED be estimated and why is this often difficult
By conducting market research like surveying a representative sample of the population asking how they might respond to a change in price of a product. But surveys are not reliable.
Or by looking at past data (what happened in the past when firms changed their prices). However, past data could be out of date.
How would you show relatively and perfectly price elastic demand on a diagram
To show relatively price elastic demand draw an almost horizontal demand curve.
To show perfectly price elastic demand draw a horizontal demand curve.
How would you show relatively and perfectly price inelastic demand on a diagram
To show relative price inelastic demand, draw a very steep demand curve.
To show perfectly price inelastic demand, draw a vertical demand curve.
