fv3 - price elasticity of demand

AP Microeconomics Unit 2 – Supply and Demand: Price Elasticity of Demand

Page 1: Introduction to Price Elasticity of Demand (PED)

  • Definition of PED

    • Measures consumer sensitivity to price changes.

    • Example: Harry vs. Sally's demand for turkey sandwiches.

      • Harry: Decreases from 5 to 1 sandwich (highly elastic).

      • Sally: Decreases from 5 to 4 sandwiches (less elastic).

Page 2: Calculating Price Elasticity of Demand

  • Formula for PED

    • ( Ed = \frac{%ΔQd}{%ΔP} )

    • ( Ed ) is the price elasticity of demand.

    • Note: ( Ed ) is typically negative due to the law of demand.

  • Example Calculation

    • Harry's demand:

      • Initial quantity (Q1) = 5, New quantity (Q2) = 1

      • ( %ΔQd = \frac{(1 - 5)}{5} \times 100 = -80% )

      • Initial price (P1) = 10, New price (P2) = 15

      • ( %ΔP = \frac{(15 - 10)}{10} \times 100 = 50% )

      • ( Ed = \frac{-80}{50} = -1.6 ) (indicates elastic demand).

Page 3: Types of Elasticity

  • Perfectly Inelastic Demand

    • ( Ed = 0 )

    • Quantity demanded remains constant regardless of price (e.g., necessities like insulin).

  • Relatively Inelastic Demand

    • ( 0 < Ed < 1 )

    • Slightly responsive to price changes (e.g., gasoline).

  • Unit Elastic Demand

    • ( Ed = 1 )

    • Proportional change in quantity demanded to price changes (e.g., luxury goods).

  • Relatively Elastic Demand

    • ( Ed > 1 )

    • Highly responsive to price changes (e.g., leisure activities).

  • Perfectly Elastic Demand

    • ( Ed = \infty )

    • Quantity demanded changes infinitely with price changes (e.g., products with many substitutes).

Page 4: Understanding Elasticity

  • Elasticity vs. Slope

    • Elasticity is not the slope of the demand curve; it varies along the curve.

  • Total Revenue Test

    • Total Revenue (TR) = Price (P) × Quantity (Q).

    • Connects total revenue to price elasticity.

Page 5: Total Revenue and Elasticity

  • Elastic Demand

    • Price increase → Decrease in TR.

  • Inelastic Demand

    • Price increase → Increase in TR.

  • Unit Elastic Demand

    • Price change → No change in TR.

Page 6: Application of Total Revenue Test

  • Purpose of the Total Revenue Test

    • Determines if demand is elastic, inelastic, or unit elastic without needing the coefficient.

    • Helps firms strategize pricing to maximize revenue.

Page 7: Key Terms to Review

  • Absolute Value

    • Represents distance from zero; important for understanding elasticity magnitude.

  • Law of Demand

    • As price decreases, quantity demanded increases, and vice versa.

  • Price Elasticity of Demand (PED)

    • Reflects consumer sensitivity to price changes.

  • Price Sensitivity

    • Degree of change in demand in response to price changes.

  • Total Revenue (TR)

    • Total income from sales; crucial for assessing firm performance.

  • Unit Elastic Demand

    • Proportional change in quantity demanded equals the change in price.

Page 8: Summary of Key Concepts

  • Understanding PED is essential for businesses and policymakers to gauge consumer behavior and adjust pricing strategies effectively.

  • Different types of elasticity provide insights into how consumers react to price changes, influencing overall