Price Elasticity of Demand (PED)

Question 1

Price elasticity of demand

Answer 1

The responsiveness of quantity demanded to a change in price

Question 2

Elastic PED

Answer 2

When quantity demanded changes more than proportionally to a change in price
- PED > 1

Question 3

Inelastic PED

Answer 3

When quantity demanded changes less than proportionally to a change in price
- 0 < PED < 1

Question 4

Unit Elastic

Answer 4

When quantity demanded changes equally proportionally to a change in price
- PED = 0

Question 5

What does the curve look like for elastic demand?

Answer 5

• the curve is very shallow
• demand is sensitive to price changes

Question 6

What does the curve look like for inelastic demand?

Answer 6

• the curve is very steep
• demand is not sensitive to price changes

Question 7

What type of goods have elastic demand?

Answer 7

• luxury goods as when prices increase the first thing people do is stop buying luxury goods so quantity falls more than proportionally

Question 8

Wat type of goods have inelastic demand?

Answer 8

• necessities as even if prices increase people still have to buy the good to live

Question 9

What should firms do when they have elastic demand?

Answer 9

firms should decrease prices to maximise profits
- demand increases alot more when prices low

Question 10

What should firms do when they have inelastic demand?

Answer 10

firms should increase prices to maximise profits
- demand doesnt fall as much even if prices increase as still buy the good

Question 11

Determinants of PED

Answer 11

1. Availabilty of Substitutes
- when high number of substitutes and very close = elastic demand as lots of competitor brands they can go to
- when low number of substitutes = inelastic demand as no other firm to buy the good from
- firms prefer to be inelastic

2. Nature of Good
- depends if good is a necessity or an addictive good as even if prices increase people will still buy the good

3. Relative Expense of good in relation to income
- if the good doesnt take up of income then demand wont be as sensitive to price changes
- if the good does take up of income then demand will be sensitive to price changes

4. Time
- overtime, more products become elastic and so PED becomes elastic
- more technological advancements so there are now close substitutes
- live in a more globalised country
- consumers can find cheaper alternatives online

Question 12

Evaluation of the determinants of PED

Answer 12

1. Availabilty of Substitutes
- depends upon how the market is defined
- if the market is wide, there is more subsitutes
- if the market is narrow, there is less substitutes
- depends upon consumer preferences and trends which may change
- depends on brand loyalty so if the price of substitutes are lower they still wont buy the good
- depends upon the quality

2. Nature of Good
- depends on if you are in a developing or developed country
- some countries the good may be a necessity for others not

3. Relative Expense of good in relation to income
- depends on the good that is being considered

4. Time
- overtime, PED may not become elastic as depends on the type of good, e.g water always remains inelastic
- consumer inertia as cannot be bothered to change even if lots of cheaper substitutes

Question 13

Why is PED useful?

Answer 13

1. Total Revenue
- helps maximise total revenue as tells them when to change prices
- if elastic = decrease price
- if inelastic = increase price
- proft increases, can reinvest

2. Tax
- when a firm is taxed they can pass this on to consumers as higher prices
- demand will only decrease less than proportionally

3. Volatility of Supply
- agriculture is inelastic as a necessity
- when prices increase, demand falls less than proportionally tothe change in price

4. Sales Discounts
- can maximise their profits
- can decrease sales and discounts for inelastic goods as need to keep prices higher for these goods

5. Price discrimination
- market segmentation as charging different people different prices
- increase prices for inelastic goods during peak times as it is a need

6. Trade Unions
- when inelastic demand, workers going to demand for higher wages as output doesnt fall as much so alot of people dont lose their jobs

Question 14

Why is PED not useful?

Answer 14

1. Only valid for marginal price changes
- when prices goes up massively, demand goes down significantly
- however in the real world, firms tend to operate marginally and increase/decrease prices by a tiny amount only

2. Estimates
- PED is always an estimate and may misinform the firm
- Might make wrong decisions that won’t maximize profit

3. May be outdated
- may go out of date due to globalization
- changes in consumer trends and preferences
- over time more goods become more close substitutes due to improvements in technology
- protection policies have gone down so can get more substitutes from other countries

4. Ceteris Paribus may not hold
- government may intervene to stop firms increasing price too much
- income
- recessions
- exogenous shocks