Price Elasticity of Demand and Related Concepts

These flashcards cover the key concepts and definitions related to price elasticity of demand, its applications, and related economic principles.

Price Elasticity of Demand (PED)

The degree to which the quantity demanded changes in response to a change in price.

PED Formula

PED = % change in quantity demanded ÷ % change in price.

Elastic Demand

Quantity changes more than price, indicating very responsive behavior.

Inelastic Demand

Quantity changes less than price, indicating not very responsive behavior.

Unit Elastic Demand

Quantity changes proportionally to price, indicating a balanced response.

Determinants of Price Elasticity of Demand

Factors that affect elasticity including substitution possibilities, budget share, and time.

Substitution Possibilities

The availability of alternative goods; more substitutes increase elasticity.

Budget Share

The proportion of income spent on a good; a higher share makes demand more elastic.

Time (in demand elasticity)

The period consumers have to adjust; elasticity increases over time.

PED – Pricing Application

Firms use PED to decide pricing strategies based on elasticity.

PED – Taxation Application

Governments tax inelastic goods to raise more revenue.

PED – Business Decision Making

PED helps firms predict consumer responses to price changes.

Percentage Change Formula

% change = (new value − original value) ÷ original value × 100.

Midpoint (Arc Elasticity) Formula

PED = (ΔQ ÷ average Q) ÷ (ΔP ÷ average P); improves accuracy.

Elastic Demand Application

If PED > 1, a price decrease increases total revenue.

Inelastic Demand Application

If PED < 1, a price increase increases total revenue.

Unit Elastic Application

If PED = 1, price changes do not affect total revenue.

Revenue Rule

The relationship between price changes, elasticity, and total revenue.

Perfectly Elastic Demand

Demand where quantity demanded changes infinitely with price changes (PED = ∞).

Example of Perfectly Elastic Demand

Identical goods in perfect competition, e.g., a single farmer selling wheat.

Perfectly Inelastic Demand

Demand where quantity demanded does not change at all when price changes (PED = 0).

Example of Perfectly Inelastic Demand

Life-saving goods with no substitutes, e.g., essential medicine.

Two Demand Curves Comparison

Elastic demand is flat and responsive; inelastic demand is steep and unresponsive.

Total Revenue / Expenditure & Elasticity

Total revenue = Price × Quantity; changes depend on elasticity.

Cross-Price Elasticity of Demand (XED)

Measures the response of demand for one good to the price change of another.

Income Elasticity of Demand (YED)

Measures the response of demand to income changes.

Perfectly Elastic Supply

Supply where firms supply any quantity at one price (horizontal curve).

Perfectly Inelastic Supply

Supply where quantity supplied is fixed regardless of price (vertical curve).

Law of Demand

As price rises, quantity demanded falls (ceteris paribus).

Needs

Basic essentials required for survival.

Wants

Desires beyond basic needs.

Utility

Satisfaction gained from consuming goods/services.

Law of Diminishing Marginal Utility

Each additional unit consumed gives less extra satisfaction.

Total Utility (TU)

Total satisfaction from all units consumed.

Marginal Utility (MU)

Extra satisfaction from one more unit.

TU & MU Graphs/Tables

TU rises at a decreasing rate; MU falls and can become zero or negative.

Rational Spending Rule

Consumers maximize utility when MU per dollar is equal across goods.

Individual Demand Curve

Shows one consumer’s demand at different prices.

Market Demand Curve

Sum of all individual demands.

Consumer Surplus

Difference between willingness to pay and the actual price.

Opportunity Cost

Value of the next best alternative forgone.

Perfect Competition

Many firms, identical products, price takers, free entry/exit.

Law of Diminishing Returns

Adding more of a variable factor eventually reduces marginal output.

Fixed Cost (FC)

Costs that do not change with output.

Variable Cost (VC)

Costs that vary with output.

Total Cost (TC)

TC = FC + VC.

Marginal Cost (MC)

Cost of producing one more unit.

Average Variable Cost (AVC)

AVC = VC ÷ Q.

Average Total Cost (ATC)

ATC = TC ÷ Q.

Profit

Profit = Total Revenue − Total Cost.

Optimal Output (Profit Max)

Profit is maximized where P = MC.

Shut-down Condition

Firm shuts down if P < AVC.

Cost Graphs/Tables

Use MC, ATC, AVC to find output, profit, and shutdown decisions.

MC & Supply Curve

MC curve above AVC represents the firm’s supply curve.

Producer Surplus

Difference between price received and minimum willingness to sell.

PED

Price Elasticity of Demand.

XED

Cross-Price Elasticity of Demand.

YED

Income Elasticity of Demand.

TR

Total Revenue (P × Q).

P (Price)

The amount charged for a good or service.

Q (Quantity)

The amount demanded or supplied.

TU (Total Utility)

Total satisfaction derived from consumption.

MU (Marginal Utility)

Extra satisfaction from consuming one additional unit.

Δ (Delta)

Change in a variable.

FC (Fixed Cost)

Costs that remain constant regardless of output.

VC (Variable Cost)

Costs that change with the level of output.

TC (Total Cost)

Sum of fixed and variable costs.

MC (Marginal Cost)

Cost of the additional unit produced.

AVC (Average Variable Cost)

Variable cost per unit of output.

ATC (Average Total Cost)

Total cost per unit of output.

P = MC

Condition where profit is maximized.

P < AVC

Condition where a firm cannot cover variable costs and may shut down.

Q* (Q star)

Optimal output level to maximize profit.

P × Q Definition

Total revenue calculation.