Price elasticity of demand (PED) Flashcards
What does PED stand for?
What is PED?
Price Elasticity of Demand
PED measures the responsiveness of quantity demanded to a change in the price of the product.
What does price inelastic mean?
If a price change leads to a smaller change in quantity, then the demand is price inelastic. This means the PED is a value between 0 and 1.
Give 3 reasons why goods or services are usually price inelastic and 3 examples
-Goods with few substitutes
-Necessities
-Addictive
-They cost a small proportion of income
-Brand loyalty
examples - Petrol - there are few alternatives/driving is a necessity
Salt, peak rail tickets, cigarettes, iPhones
What does price elastic mean?
If a price change leads to a larger change in quantity, then the demand is elastic. This means it has a PED value of > 1 (larger than 1, ignore a minus sign)
Give 3 reasons why goods or services are usually elastic and 3 examples
-Goods with many substitutes/competitive market
-Luxury/expensive items
-A large proportion of income
-Bought frequently (So likely to notice a change in price)
Examples - Tesco brand - so many better alternatives
Kitkat, porche sports car, petrol from a particular station (shell)
What is the formula for PED?
PED = (% in Quantity demanded)/(% change in price)
When is demand perfectly elastic?
if PED = 0
Demand does not change at all when the price changes - the demand curve will be vertical
What is unit elastic?
When PED = 1
This is when the % change in demand is exactly the same as the % change in price. e.g. A 15% contraction in demand, leaving total spending in the same at each price level.
What is perfectly inelastic?
When PED = 1
Demand line is horizontal
For example downloading music
Name 3 factors that influence the price elasticity of demand
- The availability of substitutes - lots of substitutions available means PED is likely elastic
- Percentage of income - greater % of income = more elastic
- Luxury or necessity
- Time period - time of year
- Costs of switching - inelastic
- Habitual consumption - more inelastic but more likely to notice price change
- Peak/off peak demand - inelastic at peak, elastic off-peak
Why is PED useful?
To make predictions:
consumers - willing to pay for inelastic products because they need too, the government may impose high tax on inelastic products or services (To reduce demand or increase government revenue ect.)
Producers - Can use their knowledge of the price elasticity of demand for their products to increase their total revenue. Knowing the elasticity, the producer would be able to calculate the effect on quantity demanded of a change in price.
Equation for total revenue (TR)
Total revenue (TR) = Price (P) x Quantity (Q)
What does PED help producers assess?
- Price volatility following changes in supply
- The effect of a change in indirect taxation on price and demand and to assess whether any price increase can be passed onto consumers
Whats the significance of both the negative sign and the absolute value (PED) in predicting change?
negative sign - Downward sloping demand curve
increase in price = decrease un quantity demanded
Absolute value - >1 = elastic, 0-1 = inelastic
- Price Elastic effect on total revenue?
- Price Inelastic effect on total revenue
Price Elastic:
Increase in price = decrease in total revenue
Decrease in price = increase in total revenue
Price inelastic:
Increase in price = increase in total revenue
Decrease in price = decrease in total revenue
