1.2.3a - price elasticity of demand

elasticity of demand is…

…an attempt to measure the responsiveness of demand to changes in other variables

PED definition

a measure of the responsiveness of demand to a change in price of the good

PED formula

%change in demand/%change in price

the result of a PED calculation will always be

NEGATIVE because there is an inverse (downwards sloping) relationship between demand and price

factors affecting PED

substitutes availability

necessity vs luxury

addictiveness

percentage of someone’s expenditure

time available to respond to price change

(snapt)

two types of demand

elastic demand

inelastic demand

elastic demand

an increase in price results in a large fall in demand

(demand very responsive to price change)

inelastic demand

an increase in price results in only a small fall in demand

(demand quite unresponsive to price change)

elastic demand qualities:

necessity/luxury
addiction
substitutes?
price
quality
time to change decision

luxury

not addictive

lots of substitutes

expensive

low quality

lots of time

inelastic demand qualities:

necessity/luxury
addiction
substitutes?
price
quality
time to change decision

necessity

addictive

lack of substitutes

cheap

high quality

little time

5 types of PED

unitary elastic
relatively elastic
perfectly elastic

relatively inelastic
perfectly inelastic

when we use a value to find out what PED type we have, how do we approach it

ignore the negative symbol, as it just shows the relationship

focus on the value, as it shows the strength of the relationship

for example, how would you describe a PED of -2

negative = direction of graph (downwards sloping)

2 = 1% price increase leads to 2% demand fall

unitary elastic PED

PED = 1

quantity demanded changes by exactly the same percentage as price

shown with a rectangular hyperbola (all the rectangles formed under it are equal in area)

relatively elastic PED

PED>1

demand changes by a larger percentage than price

demand relatively responsive to price changes

shallower line on graph (lots of demand change for small price change)

perfectly elastic PED

PED = infinity (demand change/0 = infinity)

change in price would mean quantity falls to 0 (all or nothing) - infinite change in quantity demanded

demand very responsive to price

horizontal line on graph (one price, all the demand)

relatively inelastic PED

PED<1

demand changes by a smaller percentage than price

demand relatively unresponsive to price

steep line on graph (little demand change for lots of price change)

perfectly inelastic PED

PED = 0 (0/price change)

change in price has no effect on demand

demand is completely unresponsive to price

vertical line on graph (no demand change for all prices)

what is TR

total revenue = price x quantity sold

the money the firm earns from selling their product

where on a demand curve is TR

the rectangle made when u draw lines from the axes to the curve

elastic demand total revenue

reduction in price = TR increase

percentage reduction in price = larger percentage increase in the quantity demanded (+ vice versa)

the rectangle increases in area

inelastic demand total revenue

reduction in price = TR decrease

percentage reduction in price = smaller percentage increase in quantity demanded (+ vice versa)

the rectangle decreases in area

unitary elasticity TR

reduction/increase in price = same TR

both increase/reduce by the same percentage

rectangles are all same area (rectangular hyperbola)