chapter 11 - price elasticity of demand Flashcards
(25 cards)
What is Price Elasticity of Demand (PED)?
It measures how responsive the quantity demanded is to a change in price
What is the formula for PED?
PED = % change in quantity demanded/ % change in price
What does it mean if PED > 1?
Demand is price elastic (responsive to price changes)
What does it mean if PED < 1?
Demand is price inelastic (not very responsive to price changes)
What does it mean if PED = 1?
Demand is unit elastic - the % change in quantity demanded equals the % change in price
What does it mean if PED = 0?
Perfectly inelastic demand - quantity demanded doesn’t change at all when price changes
What does it mean if PED is infinite?
Perfectly elastic demand - any increase in price causes quantity demanded to fall to zero
What type of goods tend to have inelastic demand?
Necessities with few substitutes (eg insulin, salt)
What type of goods tend to have elastic demand?
Luxuries or goods with many substitutes (eg branded soft drinks)
Name 4 main factors affecting PED.
- availability of substitutes
- necessity or luxury
- proportion of income spent
- time period considered
How does the availability of substitutes affect PED?
More substitutes make demand more elastic
How does the proportion of income spent affect PED?
The higher the proportion, the more elastic the demand
How does time affect PED?
Demand tends to become more elastic over time as consumers find alternatives
Is demand for addictive goods likely elastic or inelastic?
Inelastic, because consumers will keep buying even if prices rise
Why is PED usually negative?
Because price and quantity demanded usually move in opposite directions
Why do we ignore the minus sign in PED?
To focus on the magnitude of responsiveness, not the direction
How can firms use PED when setting prices?
They can raise prices for inelastic goods to increase revenue or lower prices for elastic goods to attract more buyers
What happens to total revenue if price rises and demand is inelastic?
Total revenue increases
What happens to total revenue if price rises and demand is elastic?
Total revenue decreases
What happens to total revenue if price falls and demand is elastic?
Total revenue increases
What happens to total revenue if price falls and demand is inelastic?
Total revenue decreases
What is the relationship between PED and necessity goods?
Necessities usually have inelastic demand
What is the relationship between PED and luxury goods?
Luxuries usually have elastic demand
Why is understanding PED important for the government?
To predict the effects of taxes or subsidies on consumption and revenue
