PED

Question 1

Price elasticity of Demand (PED)

Answer 1

Measures the responsiveness of demand to a change in price

Question 2

Formula for PED

Answer 2

% change in qty demanded / % change in price

PED value should always be negative

Question 3

Interpreting PED values

Answer 3

0 < PED < 1 = inelastic - change in price is proportionally greater than the change in demand

1 < PED < infinity = elastic - change in price is proportionally smaller then the change in demand

PED = 1 - unitary elasticity

PED = 0 - perfectly inelastic

PED = infinity - perfectly elastic

Question 4

Factors that affect PED

Answer 4

1. ) number and closeness of substitutes
2. ) Necessities vs luxuries
3. ) length of time ( no time to look for alternative )
4. ) % of income spent on good

Question 5

What happens at PED = 1 on a graph

Answer 5

revenue maximisation point

important ( not profit maximisation because total costs are not accounted for just yet )

Question 6

Explain price volatility and stability

Answer 6

inelastic graph - price volatility
Hard to predict supply required
High income change
Difficult for investment

Elastic graph - price stability
easy to predict supply required
Low income change
Easy for investment

Question 7

Relationship between PED and total revenue

Answer 7

Price inelastic demand - increase price - total revenue increases - reduced price total revenue falls

Unitary PED value - price change = no change in revenue (revenue maximisation point)

Price elastic demand - increase price - total revenue falls - reduced price - total revenue increases

Question 8

Importance of PED for firms decision making

Answer 8

Price discrimination - firms can use different PED values to charge different consumers different price for the same product

Surge pricing (dynamic pricing) - they hike the prices depending on the time of the year

Question 9

Importance of PED for government decision making

Answer 9

Determine tax policies

e.g. imposing taxes on demerit goods (cigarettes and alcohol) because they know the PED is inelastic

equilibrium price moves up, hence consumer pay most of the tax. producers pay the remainder of the tax burden. Combined together is the tax revenue for the government.

However it does little change to the consumption of cigarettes, but gov collects a lot of tax revenue