2.7 Price elasticity of demand

Effective demand

this is what the customers are willing to buy at the current price

What is the law of demand?

The law of demand states that as price increases, quantity demanded will fall. This is shown by your downward sloping demand curve. However the responsiveness of change in the quanitity demanded may very depednign on ht ecustomers degree of abilitya nd willingness ot pay.

formula and meaning for price elasticity of demand?

Price Elasticity of Demand = % Change in Quantity Demanded/% Change in Price. Measures the extent to which demand for a product changes due to a change in its price. However the responsiveness of change in the quantity demanded may vary depending on the customers degree of willignness and ability to pay.

what is inelastic demand

describes demand for a product that is unresponsive to changes in price, mainly because of the lack of substitutes for the product. Demand would change by a smaller proportion than the change in price

what si price elastic demand

Describes demand for a product that is responsive to changes in price, usually due to substitutes beign available.A fall in price have a more proportional effect on demand

why may effective demand be above or below the latent demand due to

Lack of information - don't know I want it Income constraints - things I want but cannot afford

Factors Affecting Elasticity of Demand/determinants of price elasticity of demand

-Necessity vs luxury-demand for necessities is relatively inelastic (demand doesn't change much when price changes). Demand for luxuries relatively elastic. Degree of necessity may depend on time frame eg transport may be mroe of a necessity on peak times or flowers on mothers day

-Close substitutes-if few subsitute -relatively price inelastic demand and higher price. The greater the number and availability of close substitutes there are for a good or service, the higher the value of its PED will tend to be as they are easily repalced if price increases.

- Income - The larger the proportion of income that the price of a product represents, the greater the value of its PED tends to be. if they spend only small fraction of their disposable income on an item demand more inelastic than for good they spend a lot on which would have a large impact on theri income., eg matches (relatively inelastic) or luxury foods (relatively elastic).

-Habits,addiction,fashions and tastes-if a product is addictive or hihgly fashionable PED is relatively inelastic. Or if very devoted to a hobby.

-Advertising and brand loyalty-Effective advertising can shift demand curve to the right and reduce price elasticity of demand for a product. Customers who are loyal to a brand are less sensitive to changes in price due to demanding out of habit and personal preference.

-Time period measured - short run changes are more inelastic as customers need tiem to chnage habits and behavioural norms but when measured over time become mroe elastic as customers adjust their demand based on more permanent price changes by finding alternative products

-Durability-perishable items will continue to be bought even when price rises as they need to be replaced eg milk. The more durable a product is hte mroe price elastic it tends to be as customers can postpone replacing them

-The costs of switching- if high switching cost then product tends to be price inelastic eg smartphones,laptops and cameras have specific power chargers, memory cards and softwarees. Or satellite televison subscribers are bound by lengthy contracts so swithcign less easy.

-The breadth of definition of a product- if a good or service is very broadly defined (eg food rather then fruits,salmon) demand will be mreo price inealstic as no substitutes to food or housing.

1 PED> (ignoring minus sign)

relatively elastic demand is relatively responsive to change in price

1 PED(around 0 and -1)< (ignoring minus sign)

relatively inelastic-demand is relatively unresponsive to changes in price

1 PED (ignoring minus sign)

unitary price elasticity-occurs when the percentage change in the quantity demanded (or supplied) is proportional to the percentage change in the price, so there is no change in the sales revenue.

if PED=0

perfectly price inelastic-change in price has no impact on the quantity demanded. No subsititues

if PED=inifnite

Perfectly price Elastic. This means an increase in price will cause demand to fall to zero, and a decrease will cause demand to become infinite. 

what does this picture represent

perfectly elastic. Changes-shift in supply only changes quantity

what does this picture represent

perfectly inelastic.Changes-shifts in supply only change price

what are the graphs for each type of elasticity?

when demand relatively elastic-shallow sloping curve when demand relatively inelastic-curve will be steeper A fall from P to P1 on graph-the change in quantity from Q to Q1 will be much larger for elastic demand then inelastic demand

PED can be sued to determine changes in sales revenue following a change in price.PED of product can inform firms about theri pricing startegy in order to maximise sales revenue

What is sales revenue/total revenue?

the sum of money received from sale of a good or service.

Sales revenue=quantity demeanded x price per item

doesnt include any costs that go into producing product

What is profit? (this is not the same as revenue)

Profit is the difference between a firm’s total/sales revenues and its total costs of production. Calcualted by:

Total revenue-total costs

How would firms increase revenue if demand is price-elastic?

Decrease price

How would firms increase revenue if demand is price-inelastic?

Decrease supply to increase price

How would a tax increase affect money raised and quantity consumed if demand is elastic?

Will cause a big fall in quantity so limited tax rev and a big fall in sales for makers of the taxed goods

How a tax increase affect money raise and quantity consumed if demand is inelastic?

Lot of revenue as people still buy it-customers continue to buy as many goods as before

what are monoplies

where a single supplier provides all the goods in a market

monopoly examples

gas company,oil compnay,medicine

what can monopolies do

Monopolies can reduce or increase output to alter the price of goods.They can therefore try to make very high profits

how would price increase and decrease affect revenue of product with elastic demand?

price increase-revenue will fall price fall-revenue will rise

how would price increase and decrease affect revenue of product with inelastic demand?

price increase-revenue will rise price decrease-revenue will fall

Significance of price elasticity of demand for decision makers:

PED can provide valuable information on how demand for different products is likely to change if prices are adjusted. Helsp them maximsie revenue.They can:

-Helping producers to decide on their pricing strategy: eg a buisness with price inelastic demand for its product is likely to increase price as quantity demanded will hardly be affected. Will benefit from higher sales revenue by selling at higher price.

-Predicting the impact on producers following changes in the exchange rate-eg firms that rely on exports will generally benefit from lower exchange rates,as exports become chaper and thus become more price competitive. This assumes PED of exports is price elastic.

-Price discrimination- when firms charge different customers different prices for essentially the same product because of differences in their PED. eg theme parks charge adults different prices hten chidlren and discoutns for families and annual pass holders

-deciding which products to impose sales tax on-taxing price inelastic products ensures government can collect large sums of tax revenue without seriously affect demand for product-tax can easily be passed onto consumers without impact on demand

-determining taxation policies: eg government can impose heavy taxes on demerit goods eg petrol knowing that the demand in price inelastic. As demerit goods are harmful to society, governemnt needs to impose very high levels of taxes on such products in order to reduce quantity demanded

what is exchange rate?

exchange rate changes rate at which the currency of one country will excnhange for the currency of another country-this affects revenue

What is price discrimination?

this occurs when firms charge different customers different prices for essentially the same product due to differences in PED.