PED - Price elasticity of demand Flashcards
Price Elasticity of Demand
Measures the responsiveness of the quantity demanded of a good or service to a change in price of that good or service.
Percentage change in quantity demanded/percentage change in price.
High PED
If the absolute value is greater than 1. In this situation, the percentage change in quantity demanded will be greater than the percentage change in price.
A demand curve with a high PED is one that is relatively flat (elastic).
Low PED
The product will have a low PED is the value is less than 1. in this situation, the percentage change in quantity demanded will be less than the percentage change in price.
A demand curve with a low PED is relatively steep (inelastic).
Significance of PED for businesses
Business owners would refer to operate in an environment where the goods they sell have a relatively low PED.
From their perspective, any percentage increase in price, would be associated with a smaller percentage demanded, thus an increase in revenue.
Businesses will also seek to lower the PED on their products.
Significance of PED for governments.
PED influences the type of goods that may be indirectly taxed and who pays the most tax.
The government knows that if they place an indirect tax on a product, this will result in a decrease in supply and in increase in the equilibrium. The low PED means they can generate more tax as it has a small impact on the quantity sold.
Factors affecting PED
Degree of necessity
Availability of substitutes
Proportion of income
Time
Degree of necessity
Goods and services that are deemed to be necessities will usually have a low PED, where as luxury goods will have a higher PED.
Availability of substitutes
Products that tend to have a large number of substitutes have a higher PED. If substitutes are available, consumers are likely to switch to a close substitute quickly.
Consumers decide competition.
Proportion of income
The greater the percentage of income that is needed to purchase good or service, the higher the PED. This explains why a good or service can have a low PED at low prices but may turn into a product with a high PED as rice increases.
This suggests that PED along the demand curve increases as the price increases.
Time
Over time the PED for a product might increase or decrease due to changes in behavior. In the short term many consumers may not notice a price increase or cannot be bothered seeking out a viable alternative since they might need the product now and it is a hassle to find an alternative. Over time however, consumers may start to notice the price increase and start to try other alternatives.
Example: Gas
