PED and YED

Question 1

what is meant by the price elasticity of demand? (PED)

Answer 1

measures the responsiveness of a change in demand for a good or service that results from a change in the price of that product

Question 2

why is understanding price elasticity of demand important to business managers?

Answer 2

need to know the impact of changes in price on likely levels of demand and revenue
need to know how sensitive the demand for their good is to a change in price

Question 3

explain price inelastic where PED is between 0 and -1

Answer 3

price inelastic means a change in price will lead to a less than proportional change in quantity demanded

demand is not sensitive to price changes
so if the price of a product increases the majority of people will continue to buy that product

inelastic PED likely to occur when competition levels are low, few substitutes, goods are necessities/addictive eg water, food, power, cigarettes

in these circumstances, business has more control over the price

Question 4

explain price elastic where PED is greater than -1

Answer 4

a price change will lead to a more than proportionate change in quantity demanded

demand is sensitive for the good
so if the price of a good increases, consumers will switch to a cheaper alternative eg goods that have substitutes like washing powder, cornflakes, cinema etc

in near-perfect competition, where goods are largely undifferentiated, the impact of the change in price is predictable

Question 5

explain unit elastic where PED is = -1

Answer 5

the percentage change in demand is the same as the percentage change in price

so the % rise in price of good will lead to the same % fall in demand leaving total revenue the same

Question 6

why is the PED always negative?

Answer 6

because price and quantity move in opposite directions on the demand curve

Question 7

what is the objective for most businesses in terms of PED?

Answer 7

to make the PED of their product more inelastic

they have more control over the price
they are price makers
revenue would increase

Question 8

what 3 ways can a business make their good more price inelastic?

Answer 8

encourage customer loyalty
reduce competition in the market
increase brand value

Question 9

give 4 factors that affect PED and explain them

Answer 9

number of close substitutes -
closer the substitutes, the more elastic demand is since customers find it easier to switch to another product

cost of switching between products -
if costs are involved in switching to another product, demand is likely to be inelastic

luxury/essential product -
necessities more inelastic, luxury more elastic demand

buy product out of habit -
once customer used to buying a product, less sensitive to its price
demand more inelastic

Question 10

define income elasticity of demand (YED)

Answer 10

measures the change in demand for a good that has been caused by a change in people’s income

Question 11

how is YED impactful towards businesses?

Answer 11

can be used to judge how severely a business would be impacted by economic change
fundamental part of sales forecasting
YED guides new product development

Question 12

what does real income mean and what happens to that income over time?

Answer 12

real means income that allows for the impact of inflation
increases over time leading to increased wealth and rising demand for most goods

Question 13

explain income elasticity when it is elastic

Answer 13

change in income causes more than proportional change in quantity demanded
for eg a 5% increase in income leads to a 10% increase in demand for pizza etc

Question 14

explain income elasticity when it is inelastic

Answer 14

change in income causes less than proportional change in quantity demanded
eg income falls by 4% but demand for toothpaste falls by only 2%

Question 15

explain income elasticity when it is elastic negative

Answer 15

when a rise in income causes a fall in demand
eg income rises 6% causing a fall in 5% for supermarket own brand lemonade

Question 16

explain three types of goods that impact how demand responds to a change in income and give the YED

Answer 16

normal goods - YED between 0 and 1 so income inelastic
these goods have positive income elasticity of demand
as people become better off they buy more of this type of product eg cars, furniture, washing machines etc

luxury goods - YED is greater than +1 so income elastic
more sensitive to changes in real income
as people are better off they buy more of this product
eg gym memberships

inferior goods - YED is less than 0 so income elastic negative
goods that have a negative elasticity of demand
demand rises when real incomes fall
eg supermarket own-label products rise in demand due to a recession
as income rises, consumers buy higher priced branded products

Question 17

give 2 factors that affect YED and explain them

Answer 17

degree of attractiveness of that product -
if product attractive to consumer, they will be determined to buy it even if incomes are being squeezed

how large a proportion of household income is being spent on that item -
for most a new car is a major purchase that takes a big proportion from the household budget
in contrast TV streaming services are a small proportion
so TV streaming services unlikely to be affected much by economic changes