3.1.2.2 PRICE ELASTICITY OF DEMAND

Define elasticity

Sensitivity and responsiveness of one variable to a change in another variable

• the extent to shuck demand or supply changes due to a changing factor (price)

Define price elasticity of demand

Responsiveness of the quantity demanded of a good or service to a change in its price

Define short run

A time period where at least one factor of production is fixed, meaning a business cannot easily change its scale of operations

Define long run

Period of time in which a firm can adjust its factors of production

Define very long run

Technology and automation can increase productivity further t

Define income elasticity of demand

Measure of how the quantity demanded for a good changes in response to a change in consumer income

What is the meaning of elasticity?

The change in one variable causes a change to occur in a second variable

What are the 3 types of elasticity?

• price elasticity of demand

• income elasticity of demand

• cross elasticity of demand

State the 3 types of elastic demand

• inelastic demand

• elastic demand

• unit elasticity of demand

What is inelastic demand?

PED < 1 (demand is less responsive to price changes)

Prices change but demand stays the same (petrol)

What is elastic demand?

PED > 1 (quantity demanded is more responsive ti price changes)

The demand has increased as the price has decreased

What is unit elasticity of demand?

PED = 1 (quantity demanded changes proportionally to price changes)

Demand and price have changed at the same rate

What is the calculation for price elasticity of demand?

% change in quantity demanded / % change in price

What is the calculation for income elasticity of demand?

% change in quantity demanded / % change in income

What is income elasticity of demand?

YED > 0 - normal good

0 < YED - necessity

YED > 1 - luxury

YED < 0 - inferior good

What is cross elasticity demand?

XED > 0 - substitutes

XED < 0 - compliments

How do you calculate cross elasticity of demand?

% change in quantity of demand of good A demanded / % change in price of good B

What does PED ignore?

Minuses

If the number is between 0 and 1, what is it? And if the number is more then 1, what is it?

Between 0 and 1 - price inelastic

More than 1 - price elastic

What does coefficient mean?

Answer

What does the relatively price inelastic diagram look like?

Horizontal slanted line

The change in quantity is smaller than the change in price

What does the relatively price elastic diagram look like?

Vertical slanted line

The change in price is smaller than the change in quantity

What is infinite elasticity of demand?

Demand is said to be be perfectly elastic when even a tiny change in the price causes the quantity demanded to change infinitely

What is zero price elasticity of demand?

Demand is said to be perfectly inelastic when the quantity demanded does not change at all, regardless of the price

What are the 5 demand curves?

1. Perfectly elastic demand

2. Elastic demand

3. Unit elastic demand

4. Inelastic demand

5. Completely inelastic demand

Diagram of perfectly elastic demand

Straight line horizontal

Diagram of elastic demand

Horizontal slanted line

Diagram of unit elastic demand

Curve swooping towards along the axis

Diagram of inelastic demand

Vertical line towards the left of the x axis

Diagram of completely inelastic demand

Vertical line in middle of x axis

What are the 8 facts that affect price elasticity of demand?

1. Number of close substitutes

2. Cost of switching suppliers

3. Breadth of definition of a product

4. Degree of necessity for consumers

5. Time frame available when making a choice

6. Strength of customer brand loyalty

7. Percentage income spent on a product (budget)

8. Habitual demand

Example of things that are price elastic?

Demand for soft drinks

Demand for protein porridge pots

Demand for five guys burgers

Demand for pay per view sports events

Examples of things that are price inelastic?

Demand for peak time rail travel

Demand for nespresso coffee pods

Demand for over the counter painkillers

Demand for veterinary services

What are the 6 limitations of elasticities?

1. Problems with inaccurate or incomplete data collection

2. Consumer price sensitivity changes over time

3. Elasticity of demand varies by region/time

4. Not all business are profit maximizers

5. Elasticity will vary within product ranges (premium products)

6. Rival producers will change their market strategies from time to time

Examples of things that will increase revenue?

PED is inelastic and a firm raises its prices

PED is -0.4 and the firm raises its prices by 30%

PED is -4.0 and the firm lowers prices by 15%

Examples of things that will decrease revenue?

PED is elastic and a firm raises its prices

PED is -0.2 and the firm lowers prices by 20%

PED is -1.5 and the firm raises prices by 4%

Demand curve for peak and off peak demand

Limitations of using PED analysis?

Can be inaccurate - assumes other factors remain constant

STARTER - What is a substitute good and what is a complementary good? + examples

Substitute - something that can replace another item - Colgate and oral B

Complementary - something bought necessary for the other thing - toothbrush and toothpaste, petrol and a petrol car

What is the type of demand for substitutes and complimentary goods?

S - competing demand

C - derived demand

On the demand curve, what occurs when there is a change in price and what happens when there is a change in quantity?

Price - movement along the demand curve

Quantity - extension/contraction

• demand increases - outwards shift in the demand curve

What is surge pricing? Add an example

Increasing prices when it is is highest demand

Uber would increase prices on a Saturday night as people are willing to pay to get home (price inelastic)

How do you know what the perfectly elastic and perfectly inelastic diagrams looks like?

Elastic - looks like an E - horizontal line

Inelastic - looks like an I - vertical line

If price is inelastic, and the business increase price, does this increase or decrease revenue?

Increase - loose a box of revenue but gain a bigger box (see booklet)

If price is elastic, and quantity demanded increases, what does this do to revenue?

Increases revenue (makes sense to decrease profit as you would gain more revenue)

What does PED equal for perfectly inelastic demand?

PED = 0

So if price changes, wha happens to quantity demanded?

It stays the same

What does PED equal for perfectly elastic demand?

PED = infinity

So if price stays the same, what happens to quantity demanded?

Increases

What does PED equal in unitary elastic demand?

PED = 1

What are some problems with elasticities?

• problems with inaccurate data

• consumer price sensitivity changes over time

• elasticity of demand varies by region

• not all businesses are profit maximizers

• elasticity will vary within product ranges

• rival producers will change their market strategies

If it's between 1 and 0 what is it?

Inelastic

If it's more than 1, what is it?

Elastic

If it's 0, what is it?

Perfectly inelastic

If it's infinity, what is it?

Perfectly elastic

If PED is inelastic and a firm raises its prices, what happens to total revenue?

Total revenue increases

If PED is elastic and a firm lowers its prices, what happens to total revenue?

Total Revenue increases

If PED is elastic, and a firm raises its prices, what happens total revenue?

Total revenue decreases

PED is -1.5 and the firm raises price by 4%, what happens to total revenue?

Total revenue decreases

PED is -0.4 and the firm raises prices by 30%, what happens to total revenue?

Total revenue increases

PED is -0.2 and the firm lowers prices by 20%, what happens to total revenue?

Total revenue decreases

PED is -4.0 and the firm lowers price by 15%, what happens to total revenue?

Total revenue increased

Is demand inelastic or elastic at peak and off peak prices?

At peak - demand is often price inelastic

Off peak- demand is often price elastic

Is the off peak demand or the peak demand curve lower?

The off peak demand curve is lower

What strength is strengths and weaknesses?

Evaluation (needed for a 25 marker)

Strengths of using PED analysis?

• helps businesses determine how to set prices

• helps firms to assess the effect of a change in price on total revenue

Weaknesses of using PED analysis?

• can be inaccurate/incomplete data

• ignore demand can be caused by other factors

Is a necessity inelastic or elastic?

Inelastic

Is a substitute inelastic or elastic?

Elastic