elasticity

Price elasticity of demand (PED)

Measures the responsiveness of quantity demanded to price change

Formula for PED

PED = % change in quantity demanded / % change in price

High PED

Indicates high elasticity of demand. Will have a PED value > 1. The % quantity change is greater than the price change. There will be a flatter demand curve.

Low PED

Indicates low elasticity of demand. Will have a PED value < 1. The % quantity change is less than the price change. There will be a steeper demand curve.

Perfectly inelastic demand

Completely unresponsive to price changes e.g. insulin

Significance of PED for business

Indicates impact of price change on demand and revenue, will price changes lead to dramatic increase in purchases and thus greater revenues.

Addiction impact on PED

Turns discretionary item into low PED necessity e.g. cigarettes

Luxury goods

Foregone easily, high PED, greater percentage reduction in quantity demanded when price changes.

Availability of substitutes

More substitutes lead to higher PED, consumers can switch quickly

Proportion of income impact on PED

A higher percentage of income needed to purchase leads to a higher PED, consumers are sensitive to price changes when the purchase represents a high proportion of their income.

what does elasticity refer to

it is the responsiveness (or sensitivity) of the quantity supplied or quantity demanded to changes in price

What is inelastic demand

when demand or supply is not very sensitive to changes in price
- large price increase results in small changes in demand

What is elastic demand

when demand or supply is sensitive to price changes

• small change in price results in large changes in demand

what are the factors that affect the elasticity of demand (PED)

• degree of necessity

• availability of substitute product

• time

• proportion of income

what are the factors that affect the elasticity of supply (PES)

• spare capacity

• production periods

• durability of goods

define what spare capacity means in terms of PES

refers to the resources that a business has available to them

• if the business has unused or idle resources that are available for production - elastic

• if the business is using all resources (low capacity) - inelastic

define what production periods means in terms of PES

how long it takes for a product to be produced, if a product doesnt take long to be produced it can respond quicker to price changes

• does not take long to be produced - elastic

• takes long to produce - inelastic

define what durability of goods means in terms of PES

refers to how easily a product can be stored or how perishable a product is.

• if product is not perishable, suppliers can easily take out product out of storage to respond to an increase in price to take advantage of high prices - elastic

• e.g. cola because it has preservatives

define what degree of necessity means in terms of PED

if a product is a necessity (e.g. food or water), then that product will most likely be unresponsive to price changes, therefore inelastic

define what time means in terms of PED

if a person is under a time pressure, they may not care about the price due to them not being able to find a substitute in time. e.g. water might be $4, but since you cannot find a substitute in time you will buy the product - inelastic

if the person has time, then they will be able to find a substitute and the price change does not affect them therefore elastic

define what availability of substitute means in terms of PED

if a product has many substitutes then it will be more sensitive to price changes therefore elastic

if there are not many substitutes for the product e.g luxury goods, then it wont be sensitive to price changes

define what proportion of income means in terms of PED

if you have high income, then the price of something may not seem that high due to it not being that much percent of your income. therefore elastic