3) price determination in a competitive market

Vocabulary practice flashcards covering Price Elasticity of Demand (PED), types of elasticity, determinants of elasticity, and the impact of indirect taxes and subsidies.

Price Elasticity of Demand (PED)

The responsiveness of a change in demand to a change in price, calculated using the formula: $\text{PED} = \frac{\%\Delta QD}{\%\Delta P}$.

Price Elastic Good

A good that is very responsive to a change in price, where the change in price leads to an even bigger change in demand, having a numerical value of $\text{PED} > 1$.

Price Inelastic Good

A good with a demand that is relatively unresponsive to a change in price, having a numerical value of $\text{PED} < 1$.

Unitary Elastic Good

A good that has a change in demand which is equal to the change in price, having a numerical value of $\text{PED} = 1$.

Perfectly Inelastic Good

A good with a demand that does not change when price changes, having a numerical value of $\text{PED} = 0$.

Perfectly Elastic Good

A good that has a demand which falls to zero when price changes, having a numerical value of $\text{PED} = \infty$.

Necessity (PED Factor)

A factor influencing elasticity where necessary goods (such as bread or electricity) have relatively inelastic demand because consumers need them, whereas luxury goods (such as holidays and flights) are more elastic.

Availability of Substitutes (PED Factor)

The closer, more available, and more numerous the substitutes are (such as Android phones for iPhones, or white bread compared to the broader market for bread), the more price elastic the demand.

Time Horizon (Short Run vs. Long Run)

In the short run, demand is more inelastic because consumers lack time to respond; in the long run, demand becomes more price elastic because consumers have time to find a substitute.

Habitual Consumption / Addictiveness

A factor where goods such as cigarettes are not sensitive to changes in price because consumers become addicted to them and continue purchasing them regardless of price increases.

Proportion of Income Spent

Goods taking up a small proportion of income (such as a magazine price increase from $£1.50$ to $£2$) have relatively inelastic demand, while goods taking up a significant proportion (such as a car increasing from $£15{,}000$ to $£20{,}000$) have more elastic demand.

Durability of the Good

A characteristic where goods that last a long time (such as a washing machine) exhibit more elastic demand because consumers can wait before purchasing another one.

Peak and Off-Peak Demand

A condition where demand becomes more price inelastic during peak times, such as $9\,\text{am}$ and $5\,\text{pm}$ for train tickets.

Indirect Tax Incidence on Inelastic Goods

When demand is inelastic, firms shift most of the tax burden onto consumers because demand will not drop significantly, shifting supply from $S1$ to $S2$, raising price from $P1$ to $P2$, and serving as the most effective method for raising government revenue.

Indirect Tax Incidence on Elastic Goods

When demand is elastic, firms absorb most of the tax burden themselves to avoid a sharp drop in demand and revenue; it is not as effective for raising government revenue, but effective for reducing consumption from $Q1$ to $Q2$.

Subsidy

A payment from the government to firms to encourage the production of a good and to lower their average costs, which has the opposite effect of a tax by increasing supply.

Distribution of Subsidy Benefits

The distribution of a subsidy's gains between the producer in the form of increased revenue ($C - P1$) and the consumer in the form of lower prices ($P1 - P2$).