Uses Of Elasticities Of Demand Flashcards
Factors that influence the price elasticity of demand
Substitutes
Type of good or service
Percentage of income spent on good
Time
Substitutes
The more substitutes a good has the more price elastic demand is.
Type of good (or service)
Demand for essential items is price inelastic.
Non essential price elastic.
Habit forming goods price inelastic.
Purchases that cant be postponed price inelastic
Demand for product with different uses price inelastic.
Percentage of income spent on good
Demand for products that require large proportion of consumers income more price elastic.
Time
Long run demand becomes more price elastic
Habits change
Easier to change to alternatives time to look at what’s available.
Elasticity changes along
A straight demand curve
Explain elasticity changes along a straight line demand curve
PED changes from minus infinity at high price/zero demand
Through an elasticity of minus one at the midpoint
To an elasticity of zero at 0 price/high quantity demanded
When it total revenue maximised on a demand curve
When the PED = -+1
The nearer a firm sets a products price to the midpoint of demand curve the higher the total revenue will be.
Diagram on p20 if needed.
If good has elastic demand then
A reduction in price will increase the firms total revenue.
An increase in price will reduce the firms total revenue
If a good had inelastic demand
A reduction in price will reduce a firms total revenue
An increase in price will increase a firms total revenue
Income elasticity of demand is different
For normal and inferior goods.
YED for normal goods.
Positive YED so between 0 and 1.
As income rises, demand increases.
YED for luxury goods
Elastic
YED>1
YED of inferior goods
Negative YED
YED<0
As income rise, demand falls.
Cross elasticity of demand is used to show
If goods are substitutes or complements.
Closer the substitute the higher the positive XED
Goods with XED of 0 are independent unrelated goods.
Knowledge of Elasticities of demand is useful for
Firms and governments.
Usefulness of Elasticities of demand
YED sales forecasting
YED pricing policy
Products with different YEDs for stability of a firm
Knowing XED useful to react to changes in price of related products to maximise demand of theirs.
Useful for gov to know how demand for goods might change during booms and recessions for their policies.
YED for sales forecasting
If YED and likely changes in income are known than sales levels can be predicted.
YED pricing policy
A reduction in price for a normal good,
when there’s an expected fall in incomes,
may limit the expected reduction in demand for the good.
Firm wants to stay stable
Can be achieved with products with different YEDs
During boom demand for products with high YEDs increase.
Firms may also supply products with low YED so can still earn revenue in recession.
Why is it useful for a firm to know XEDs of their goods?
It will tell them how to react to changes in the price of related products to ensure they maximise demand for their products.
Elasticites of demand useful for gov because
Demand for goods might change during booms and recessions.
So useful to know when setting their policies.
