PED Flashcards
Define price elasticity of demand
PED- is a measure of how the QD of a product changes owing to a change in a factor that affects demand
Define price inelastic demand
Price inelastic demand occurs when a small change in the price of a product causes a smaller proportionate change in the quantity demanded.
Define price elastic demand
Price elastic demand occurs when a relatively small change in the price of a product causes a larger percentage change in the quantity demanded.
Formula of PED
PED formula = %change in QD ÷ % Change in Price
Why is the value of PED negative?
The value of PED is negative owing to the law of demand. An increase in the price of a product tends to cause a fall in the QD.
Determinants of PED?
H-habits
I- Income- the greater the proportion of consumer’s real income spent on a product, the more price elastic it will be, cp.
N- Necessity- products that are regarded as essential tend to be price inelastic. By contrast, the demand for luxury products is relatively price elastic.
T- time- over time, a good tends to become more price elastic because consumers and firms have more time to find substitutes.
S-substitution- the greater the number and availability of close substitutes there are for a product, the higher the value of its PED tends to be.
Relationship between PED and total revenue?
Price elasticity of demand is of extreme usefulness to firms trying to increase their revenues by raising prices. This is because price elasticity of demand informs business decision makers about the effect of price changes on sales revenue thus instrumental in their decision making.
price elasticity of demand informs firms with a high price elastic demand for its product of the dangers of trying to increase their revenues by raising prices. This is because, if demand is highly price elastic and the firm increases prices, customers would switch to other close substitutes that are widely available, thereby generating a net loss in total revenue. Hence, price elasticity of demand warns such a firm from taking the decision of increasing prices in attempt to increase total revenue for they will incur a net loss in total revenue rather than increasing it. Thus, price elasticity of demand proves to be essential to a firm with a high price elastic demand.
Income elasticity of demand measures?
Measures the degree of responsiveness of demand following a change in the income.
YED formula?
%change in QD ÷ %change in Income (Y)
Income inelastic demand occurs when?
YED<1 Occurs when demand is relatively unresponsive to a change in consumer’s real income.
Income elastic demand occurs when?
YED >1 occurs when demand is relatively responsive to a change in consumer’s real income.
Negative coefficient of YED suggests?
The product is inferior good
Why do normal goods have positive YED?
Because the QD increases along with an increase in real income.
YED >1 means?
It means any given change in real income will lead to a greater percentage change in QD.
YED <1 (inelastic) means?
Any given change in real income will lead to a smaller percentage change in QD.
What is the importance of YED?
PED for primary commodities
The value of PED for primary commodities (raw materials) such as crude oil and iron ores is
relatively low. This is due to the main determinants of PED for primary products:
Primary commodities such as rice lack close substitutes. For example, there are few
alternatives for coal, crude oil, gold, metal ores and rice.
They are essential (necessities) for production, so their demand is relatively price inelastic.
The proportion ofincome spent on primary products is relatively low. The price of primary
commodities used for production tends to account for a smaller proportion of overall costs of
production, as labour and capital costs tend to be higher.
The time needed to grow and harvest or extract primary commodities is a lot longer than the
process to manufacture goods. The shorter the time period under consideration, the lower the
value of PED.
PED for manufactured goods
the demand for manufactured products (such as motor vehicles, laptops, watches
or furniture) is relatively price elastic.
Most manufactured products have many substitutes; for example, different makes and models
of cars, laptops and watches.
The degree of necessity is lower, as customers might be able to use their existing manufactured
products (such as furniture) for longer in response to higher market prices or can switch to
cheaper alternatives.
Manufactured products such as motor vehicles take up a larger proportion of consumers’
income and therefore demand is relatively price elastic.
Manufactured products such as laptops can be used continuously over a long period oftime,
so PED tends to be higher in value.
