Price Elasticity Of Demand 1.7 Flashcards
Price Elasticity of Demand (PED)- Definition
Price Elasticity of Demand (PED) measures how the quantity demanded of a good responds to a change in its price. It indicates the sensitivity of consumers to price changes.
PED
Positive Value: Indicates a direct relationship (common in normal goods).
Negative Value: Indicates an inverse relationship (common in demand curves, often reported as positive for simplicity).
Types of Price Elasticity of Demand-Price Inelastic Demand (PED < 1)
Characteristics:
Demand changes less than proportionately to price changes.
Consumers are less responsive to price changes.
Example: Necessities like fuel or basic food items.
Types of Price Elasticity of Demand-Price Elastic Demand (PED > 1)
Characteristics:
Demand changes more than proportionately to price changes.
Consumers are more responsive to price changes.
Example: Luxury goods or products with many substitutes.
Types of Price Elasticity of Demand-Unitary Elastic Demand (PED = 1)
Demand changes proportionately with price changes.
Factors Influencing Price Elasticity of Demand- Availability of Substitutes
More substitutes = more elastic demand.
Example: Butter vs. margarine.
Factors Influencing Price Elasticity of Demand-Necessity vs. Luxury
Necessities tend to have inelastic demand; luxuries are often elastic.
Factors Influencing Price Elasticity of Demand-Time Period
Demand may become more elastic over time as consumers find substitutes
Factors Influencing Price Elasticity of Demand-Proportion of Income
Items that take up a large portion of income tend to have more elastic demand.
Example: Cars vs. matches.
Factors Influencing Price Elasticity of Demand-Branding and Loyalty
Strong brands can make demand more inelastic due to consumer loyalty.
Implications for Businesses- Pricing strategies
Inelastic Demand: Price increases can lead to higher total revenue.
Example: Utility companies often raise prices without significant drops in demand.
Elastic Demand: Price increases can lead to lower total revenue; firms should consider lowering prices to boost sales.
Example: Retailers may offer discounts during sales.
Total Revenue Calculation
Total Revenue (TR) = Price (P) × Quantity (Q).
Understanding how PED affects TR can guide pricing decisions.
Market Competition
In competitive markets, firms must understand the elasticity of demand to set prices that maximise revenue without losing customers to competitors.
Why is it crucial?
Elasticity of demand is crucial for businesses in developing effective pricing strategies. By recognising the nature of their products’ demand elasticity, companies can make informed decisions that maximise revenue and market share.
Key Takeaway
Inelastic Demand: Price increases → TR increases
Elastic Demand: Price increases → TR decreases
