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Price elasticity of Demand (Unit 11) - Coggle Diagram
Price elasticity of Demand (Unit 11)
Definition: measure the change in demand for a product due to a change in its price
Price elastic & inelastic
demand
Price inelastic demand:
describe demand for a product that is
unresponsive
to changes in price due to lack of substitutes for the product
Price elastic demand:
describe demand for a product that is
responsive
to changes in price usually due to other substitutes being available
Calculation for price elasticity of demand:
Percentage change in
quantity demanded
:heavy_division_sign: percentage change in
price
If a PED for a product is
less than 1
--> price inelastic
If a PED for a product is
more than 1
--> price elastic
Special cases:
-> If a PED for a product is
equal to 0
=> perfectly price inelastic
-> If a PED for a product is
equal to infinity
=> perfectly price elastic
-> if PED for a product is
equal to 1
=> unitary price elasticity
Determinants
of PED:
Substitution
:
high number & availability of close substitute for goods & services ---> higher the value of PED (elastic)
WHY
?
the products can be easily replaced if price increases due to high number of close substitute.
in
contrast
, products with few substitute have relatively price inelastic demand (such as prescribed medicines & private education)
Income
:
the larger the proportion of income a product represent (take up), the greater the value of PED (elastic)
Necessity
:
products that are essential (often food, fuel, medicines) tend to have relatively price inelastic demand
because people needed this products for their daily life
In contrast, demand for expensive & luxury goods will have a relatively price elastic demand as people does not need it
Habits, addictions, taste & fashion:
if produce are habit forming & trendy/fashionable, the demand for this product will have relatively price inelastic demand.
people who have hobbies (such as music -> album), they are more willing to pay even at higher price
[
think about k-pop fan buying album
]
therefore, demand from these people are less sensitive to changes in price
Advertising & brand loyalty:
effective & successful advertising for certain products usually have relatively price inelastic demand (more demand)
customers who are loyal to certain products are less sensitive to changes in the prices of products --> because they prefer this brands products than rival brands (suitable to their preferences)
Time
:
! read in textbook pg 52 cause it's quite confusing !
summary: people need time to change habit & behavioural norms therefore in the long run they might choose other products if they think the prices is too high for them to afford
Durability
:
products that are perishable & need to be replaced will have relatively price inelastic demand
because people will continue to buy them even though there is rise in prices
In contrast, products that are durable and long lasting, usually if the price increase, people will decide to postpone by replacing other items due to high price
SO, the more durable a product, the more price elastic its demand tend to be
Costs of switching :
high switching costs have relatively price inelastic demand as people are less sensitive to change in price
because people cannot easily switch products due to high prices
(not quite understand)
Breadth of definition of products:
if goods & services is broadly defined (such as food instead of meat, apple, salmon), demand for it tends to be price inelastic
because there is no substitute to the products
BUT to measure price elasticity of demand, it will be useful to measure specific products such as IGCSE textbooks
ESSAY
Relationship between PED and total revenue
Definition
:
Sales revenue
: -
sum of money received from the sale of goods & service
calculation:
price :heavy_multiplication_x: quantity demanded
Profit:
the difference between firm's total revenue and its total cost
calculation: TOTAL REVENUE - TOTAL COST
pg 54 (more clearer)
Importance
of PED for decision makers:
Helping producers to decide their pricing strategy:
business with price inelastic demand for its products is likely to increase products knowing the customer will be less sensitive to price changes
therefore firm can benefit from higher sales revenue when selling its products at a higher price (price inelastic demand)
Predict the impact on producers following changes in exchange rate:
firms that rely on exports ( ) will benefit from lower exchange rate as exports becoming cheaper thus becoming more competitive
PED for exports is price elastic
Price discrimination:
occurs when firm charge different customer with different prices for the SAME product due to the differences in PED
for example, going to a theme park, where they charge different prices for adults and children
Deciding which products to impose sales taxes on: (gov. & producer) :
taxing on price inelastic products & gov. can still collect large sums of tax revenue without affecting the demand for the product
producers can also decide how much taxes to impose on customers such as petrol, alcohol which are inelastic in demand to collect tax revenue maybe for development of country
Determine taxation policies (gov.)
help gov. to determine taxation policies for example the gov. can impose on heavy taxes on demerit goods such as cigarettes as these product are price inelastic
as demerit goods are harmful to society, the gov. can impose high level of taxes on these goods to reduce the quantity demanded
ESSAY
