Please enable JavaScript.
Coggle requires JavaScript to display documents.
Price Elasticity of Demand (Elasticity (Elastic: PED is MORE than 1 The %…
Price Elasticity of Demand
It is a measure of the responsiveness of the quantity demanded of a good or service to changes in price.
Calculating PED
% change in Qd / % change in P
The quantity demanded of beer increases by 15% as the price of beer falls by 10%. PED?
PED = 15%–10% = −1.5
PED = 1.5
Always take the ABSOLUTE VALUE
For every 1% change in the price of beer, the Qd changes 1.5%
Elasticity
Elastic
: PED is MORE than 1
The % change in Qd > % change in price
Qd is responsive to changes in price
Inelastic
: PED is LESS than 1
The % change in Qd < % change in price
Qd is not very responsive to changes in price
Unitary elastic
: PED = 1
The % change in in Qd = % change price
Perfectly Inelastic
: PED = 0
The % change in Qd = 0
No matter what happens to price there is NO change
Perfectly elastic
: PED = infinity
A change in price = infinitely larger change in Qd
Determinants
Proportion of income
The greater it is the more elastic the demand
The proportion of income an object / resource takes
e.g. if a holiday takes a bigger proportion than a restaurant, the holiday will be in a more hesitant situation
Substitute
2+ goods that satisfy a similar need & how close they are
If the price of a good increases with many substitutes, consumers can switch to the substitute product resulting in a large drop in demand.
The more it is/ there are, the more elastic the demand is = high PED
Time
The more a consumer has the more elastic the demand
e.g. :arrow_up: gasoline = over a short time there will be a small :arrow_down: in Qd. As time goes on, consumers will have more of an opportunity to switch to other forms of transportation
Necessity v luxury
The more necessary a good the less elastic the demand
e.g. Food is a necessity. If P:arrow_up:, Qd will not :arrow_down: a lot
A special case of a necessity is an addiction such as alcohol, drugs, smoking etc.
Application of PED
Primary commodities v. manufactured goods
Most primary commodities have an inelastic demand as they do not have close substitutes and are necessities. Manufactured goods are usually not as necessary and have close substitutes thus, they have a higher PED value (are more demand elastic)
Total revenue
The total amount of money received by firms when a g or s is sold
== P x Q (price of the g x quantity sold) for the total
Elastic
An :arrow_up: in P = :arrow_down: TR (due to fall in Qd)
A 10% increase in P will result in more than a 10% decrease in Qd (due to PED > 1). The impact on TR is bigger than the decrease in P thus, TR falls.
Inelastic
An increase in P causes an increase in TR and vice versa.
Due to PED > 1, the % change in Qd is smaller than that of P. Thus, a 10% P increase, would cause a smaller decrease in Qd. TR rises.
Unit elastic
% change in Qd = % change in P. Thus, there is no change to TR
The gain in TR matches the loss. Thus, it remains unchanged
In the first part, P are high thus, D is highly elastic. A firm can increase its TR by decreasing price. TR will continue to increase as P falls until it reaches the unitary elastic part of the diagram (part 2).
As P continues to fall, the firm will begin to experience a loss in TR as well due to inelastic D.
Thus, TR is at a max where D is unit elastic
Indirect taxes
Governments impose taxes on specific goods that they know have a lower PED - are more inelastic.
As, the lower the PED for the good, the greater the tax revenue for the government as consumers still consumer irrelevant to the change in price
When tax is imposed on a good, S :arrow_down: due to :arrow_up: in P, The difference between the initial curve and the final is the
'tax per unit'
.
The new equilibrium changes to Pc (price to consumer). Pp is price received by producer. In the diagrams, the steeper the D (more inelastic) the greater the revenue to gov.
How do elasticities affect the firm's TR?