Temp: PED to PES

Part of 1.2 How Markets Work: 1.2.3 and 1.2.5: Includes price, income and cross elasticities of demand as well as price elasticity of supply.

price elasticity of demand (PED)

the responsiveness of quantity demanded towards a change in price

PED formula

percentage change formula

elastic demand

a bigger change in demand compared to price

(PED coefficient greater than 1)

inelastic demand

a smaller change in demand compared to price

(PED coefficient less than 1)

reasons for goods being elastic

they are not necessities

they have many substitutes

reasons for goods being inelastic

they are necessities

they have very few substitutes

they are habitual

they are luxuries (eg. a Ferrari is always expensive but bought no matter the cost)

factors affecting PED

Number of substitutes

Cost of switching suppliers

Breadth and definition of a product

Necessity for consumers

Time available to make a choice

Brand loyalty

% of income spent on a product

Habitual demand

perfectly inelastic

consumers are willing and able to pay any price for the product (PED = 0)

perfectly elastic

consumers are willing to pay the same price for different quantities of the product (PED = ∞)

unitary elastic

percentage change in demand is equal to the percentage change in price (PED = 1)

perfectly elastic, inelastic and unitary elastic represented on a graph

total revenue

what the company earns by selling a product

total revenue = price ✕ quantity demanded

effects of price changes on elastic and inelastic goods

For an increase in price:

elastic good - total revenue falls

inelastic good - total revenue rises

For a decrease in price:

elastic good - total revenue rises

inelastic good - total revenue falls

total revenue curve

demand curve showing elastic, unit elastic and inelastic

(we were taught TR graph goes on top)

income elasticity of demand (YED)

the responsiveness of the quantity demanded towards a change in consumer income

positive YED relationship

a rise in income will lead to an increase in the quantity demanded

negative YED relationship

a rise in income will lead to a decrease in the quantity demanded

interpreting a positive or negative YED value

Normal goods:

Necessities - goods or services that are essential

(Positive YED value less than one)

Luxury goods - goods of a more extravagant standard

(Positive YED value more than one)

Inferior goods: goods of a lower quality

(Negative YED value)

income elasticity of demand (YED) formula

YED elastic

a change in income leads to a greater change in demand

(coefficient greater than 1)

YED inelastic

a change in income leads to a smaller change in demand

(coefficient less than 1)

cross elasticity of demand (XED)

the degree of responsiveness of quantity demanded for a given product after a change in price for another product

XED formula

substitute goods

alternative products that can be used to replace another good

(positive XED coefficient)

eg. tea and coffee

complementary goods

products that are consumed or used together

(negative XED coefficient)

eg. pen and paper

unrelated goods

Price change of Good Y causes zero change in Qd of Good X

XED = 0

XED inelastic

XED coefficient is less than 1

XED elastic

XED coefficient is more than 1

strong substitutes

a change in price of good X leads to a greater change in demand for good Y

XED coefficient is positive and more than 1

weak substitutes

a change in price of good X leads to a smaller change in demand for good Y

XED coefficient is positive and less than 1

strong complements

a change in price of good X leads to a greater change in demand for good Y

XED coefficient is negative and more than 1

weak complements

a change in price of good X leads to a smaller change in demand for good Y

XED coefficient is negative and less than 1

loss leaders

products sold at a loss where the profit comes from selling associated complementary goods

eg. selling an Xbox console at a loss to sell more games and controllers for profit

price elasticity of supply (PES)

the degree of responsiveness of quantity supplied to a change in price

PES formula

PES inelastic

PES coefficient less than 1

PES elastic

PES coefficient more than 1

perfectly inelastic supply

as price changes there is no change in quantity supplied (PES = 0)

eg. cinema seats (anything with a capacity)

perfectly elastic supply

as quantity supplied changes there is no change in price (PES = ∞)

eg. agricultural goods or government price caps

unitary elastic supply

percentage change in supply is equal to the percentage change in price (PES = 1)

factors affecting PES

spare production capacity

stocks of finished products, components and perishability

ease and cost of factor substitution/mobility

time period and production speed

elastic if a firm can respond quickly:

(has spare capacity, has high stocks, no perishable goods, easily reallocates goods, produced quickly)