Price Elasticity of Demand

Question 1

What is the PED formula?

Answer 1

-% change in quantity / % change in price.

Question 2

What is elasticity?

Answer 2

-The responsiveness of X to a change in prices or another variable.

Question 3

What is PED?

Answer 3

• Price elasticity of demand measures the responsiveness of demand after a change in the good’s own price.
• All normal goods with downward sloping demand curves will have a negative coefficient of price elasticity of demand.

Question 4

What are the numerical values for coefficient of price elasticity?

Answer 4

• If PED = 0, demand perfectly inelastic, demand does not change when the prices change. Demand curve vertical.
• If PED between 0 to 1, % change in demand smaller than % change in price. This means demand is inelastic.
• If PED = 1, % change in demand is same as % change in price. Demand is unit elastic
• If PED >1 , demand responds more than proportionately to change in price, demand is elastic.

Question 5

What are the factors that determine the PED of a product?

Answer 5

• Number of close substitutes available for consumers, more close substitutes more price elastic the demand.
• Price of product in relation to total income, when % of budget high, demand will tend to be price inelastic.
• Brand loyalty and habitual consumption, high levels of brand loyalty makes demand less price elastic. Persuasive advertising can make demand price inelastic.

Question 6

What is inelastic demand and what is the graph?

Answer 6

• If co-efficient of price elasticity of demand <1 then demand is said to be price inelastic, unresponsive to change in price.
• If coefficient of PED is <1 a rise in market price (P1 to P2) will lead to increase in total revenue for seller of the product. There is also lost revenue from the contraction in quantity sold.

Question 7

What are rare earth metals?

Answer 7

• Essential raw material in the manufacture of solar cells and batteries and car catalysts.
• China is dominant supplier of rare earths producing over 90% of world output.
• Lack of substitutes makes demand price inelastic. Low PED provides China with source of monopoly power creating conditions where China can restrict exports of rare earth metals causing prices to rise which would increase their total revenue.

Question 8

What is elastic demand and what is the graph?

Answer 8

• If coefficient of price elasticity of demand >1, demand is price elastic and is said to be highly responsive to changes in price.
• If demand for product is price elastic, supplier stands to gain revenue if they reduce their prices, meaning change in quantity demanded will be proportionately higher than the reduction in price.

Question 9

What is perfectly inelastic demand and what is the graph?

Answer 9

• If coefficient of price elasticity of demand = zero, demand perfectly inelastic. It does not vary with a change in price.
• Perfectly inelastic demand curves are usually and extreme case and implies customers are willing and able to pay and price for the product.
• If supply falls, equilibrium market price can rise without any contradiction in quantity demanded.

Question 10

What is perfectly elastic demand and what is the graph?

Answer 10

• If coefficient of PED = infinity, demand perfectly elastic, there is one price where consumers are prepared to pay.
• If demand is perfectly elastic, change in market supply will not lead to any change in equilibrium price.
• This demand curve applies to highly competitive markets where no supplier has any “pricing power”.

Question 11

What is the co-efficient of PED along a linear demand curve.

Answer 11

• PED varies along the curve.
• Price elasticity of demand along straight line demand curve will vary.
• At high prices, reduction in price will have an elastic price response, lower prices cause total revenue to rise. Therefore PED >1 (elastic)
• Demand is price inelastic towards bottom of demand curve, fall in price causes total revenue to drop. Therefore PED <1 (inelastic)

Question 12

What is the usefulness of price elasticity of demand for producers?

Answer 12

• Firms can used PED estimates to predict:
• Effect of a change in price on total revenue of sellers.
• Price volatility in a market following changes in supply. Important for commodity producers who suffer big price and revenue shifts from one time period to another.
• Effect of a change in an indirect tax on price and quantity demanded and also whether the business is able to pass on some or all of the tax onto the consumer.

Question 13

What are the limitations of elasticities?

Answer 13

• Problems with inaccurate or incomplete data collection.
• Consumer price sensitivity changes over time.
• Elasticity of demand varies by region / time.
• Not all businesses are profit maximisers.
• Elasticity will vary within product rangers, economy and premium products.
• Rival producers will change their market strategies from time to time