Price Elasticity of Demand

Question 1

explain the factors that affect price elasticity of demand.

Answer 1

availability of substitutes: the closer the substitutes and the more that are available, the higher the price elasticity of demand

income: if consumer incomes are higher than the issue of price becomes less important to the consumer and it is easier for firms to increase price as PED is lower

nature of the good: a luxury good will be price elastic as demand will be more sensitive to the changes in price however, a necessity will be price inelastic as demand will be less sensitive to changes in price

Question 2

explain the difference between price elastic demand and price inelastic demand

Answer 2

price elastic demand means that demand is very responsive to a change in price

• if the price of a good goes up, demand will fall by a greater proportion
• if the price of a good goes down, demand will rise by a greater proportion

price inelastic demand means that demand is not very responsive to a change in price

• if the price of a good goes up, demand will fall by a lesser proportion
• if the price of a good goes down, demand will rise by a lesser proportion

Question 3

describe the implications of price elasticity of demand for producers and consumers

Answer 3

if a good is price elastic then producers should lower price

• this will lead to a rise in demand and a rise in revenue
• producers will have to ensure that unit costs are low enough to cover selling prices
• consumers will benefit from lower prices

consumers will have less options available if goods are price inelastic

• the government will try and create competition in order to stop firms from raising price
• overtime, new producers will enter markets, which will increase competition
• however, firms with a price inelastic good will try to maintain this advantage over a period of time