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)
