Unit 2.5, 2.6: Elasticity Of Demand Flashcards
Price elasticity of demand (PED)
Measures the responsiveness of quantity demanded relative to price
Price elasticity of demand formula
PED = (Q2-Q1)/Q1 ÷ (P2-P1)/P1
Price elastic demand
PED > 1
A change in price leads to a proportionally greater change in quantity demanded
A 1% change in price leads to a portionately greater change in Qd (>1%)
Price inelastic demand
PED <1
A change in price leads to a proportionally smaller change in quantity demanded
A 1% change in price leads to a portionately smaller change in Qd (<1%)
Unitary elastic demand
PED = 1
A change in price leads to a proportionally equal change in quantity demanded
A 1% change in price leads to a 1% change in Qd
Perfectly inelastic demand
PED = 0
A change in price leads to no change in quantity demanded
A change in price has no impact on Qd
Perfectly elastic demand
PED = ∞
A change in price leads to a infinite change in quantity demanded
A change in price leads to zero change in Qd
Determinants of PED
SPLAT
- Substitutes
- Proportion of income
- Luxury or necessity
- Addictiveness
- Time
PED can be useful to a firm’s revenue decisions because…
It decides whether to increase or decrease price in order to maximise total revenue
Limitations of PED as a result of…
- Ceteris paribus: In real-life there are many other factors affecting revenue that need to be considered. Price is not the only determinant of demand!
- PED changes over time so data needs to be updated regularly —> firms may not have accurate data
- PED can be hard to calculate
- Different consumer groups may have different PED
Income elasticity of demand (YED)
Measures the responsiveness of quantity demanded to a change in real income of consumers
Income elasticity of demand (YED) FORMULA
YED = (Q2-Q1)/Q1 ÷ (Y2-Y1)/Y1
Interpretations of YED - Necessities
0<YED<1
Goods and services used to satisfy basic needs where consumer demand does not increase or decrease significantly with changes in income
(E.g. toothpaste, toothbrush, toilet paper)
Interpretations of YED - Luxury Goods
YED>1
Goods and services used to satisfy wants and indulgences where demand changes proportionally greater to the change in income
(E.g. mechanical watches, designer clothes, sports cars)
Interpretations of YED - Inferior goods
YED<0
Goods and services with more expensive and higher quality counterparts
(E.g. microwave meals, instant noodles)
Price elasticity of supply (PES)
Measures the responsiveness of quantity supplied relative to price
Price elasticity of supply (PES) FORMULA
(Q2-Q1)/Q1 ÷ (P2-P1)/P1
ALWAYS GREATER THAN OR EQUAL TO ZERO
Determinants of PES
MUT
M - Mobility of FOPs
U - Unused capacity and inventory
T - Time allowed to adjust FOPs
Price inelastic supply
0<PES<1
Quantity supplied is relatively unresponsive to price
Price elastic supply
1<PES<∞
Quantity supplied is relatively responsive to price
Unit elastic supply
PES=1
Percentage change in quantity supplied equals percentage change in price
Perfectly inelastic supply
PES=0
Quantity supplied is completely unresponsive to price
Perfectly elastic supply
PES= ∞
Quantity supplied is infinitely responsive to price
