1.5 price elasticity of demand (PED)

Elasticity Demand (PED) measures

how much the quantity demanded changes in response to a change in price. It shows how responsive consumers are to a change in price

ELASTIC - “sensitive” - a small price change causes a big change in quantity demanded

PED > 1

Inelasticity Demand

“not sensitive” even when prices change people will keep buying about the same amount

PED <1

What does it mean when demand is inelastic?

Demand is elastic when quantity demanded changes less than the price change (PED <1) consumers are less responsive to price changes.

Unit elastic

when the percentage change in quantity demanded equals the percentage change in price (PED=1)

Primary commodities

Basic raw materials that come straight from nature

Manufactured products

• things that are (built) made from raw materials, usually in factories.

• made from primary commodities

Are primary commodities generally elastic or inelastic in demand? why?

Primary commodities tend to have inelastic demand because they are often necessities with a few substitutes

Are manufactures products generally elastic or inelastic in demand? why?

Manufactured goods often have more elastic demand because there are more substitutes and they may be seen as luxuries

Why is PED important for governments when imposing indirect taxes?

1. If demand is inelastic a tax will raise significant revenue because consumers keep buying despite higher prices

• producers can just pass that tax on consumers in form of price rise

1. If demand is elastic, a tax causes a big drop in quantity demanded so tax revenue may be lower

• businesses loose revenue (cut workers) this could increase unemployment

How does elastic demand affect total revenue when prices change?

with elastic demand increasing price decreases total revenue

How does elastic demand affect total revenue when prices change?

with inelastic demand increasing price increases total revenue

Factors determining whether demand is elastic or inelastic

1. number of substitutes

more substitutes = elastic

2. necessity vs luxury

necessities = inelastic

3. proportion to income spent

larger share = elastic

4. Time (consumers need time to adjust to their behaviour)

longer time = more elastic

How does PED differ in short run and long run ?

SHORT RUN: Demand tends to be more inelastic because consumers have less time to adjust their behaviour or find alternatives

LONG RUN: Demand tends to be more elastic because consumers have more time to change habits, find substitutes or switch products