Price Elasticity of Demand

Price Elasticity of Demand

1. A measure of the sensitivity of quantity demanded to a change in the price of a good or service

2. PED

   • Always negative
     • Due to the relationship between QD and Price
     • Ignore the minus sign to interpret

3. Types of PED

   • > 1
     • Good is very responsive
       • consumers respond to a change in price
     • Very elastic
   • < 1
     • Not very responsive
       • consumers don't respond to a change in price
     • inelastic
   • = 1
     • Unit elasticity
       • % change in price and QD are the same
   • = 0
     • Perfectly inelastic
     • Not responsive
       • A change in price has no impact on QD
   • Infinite
     • Very responsive
       • if price increases, demand disappears

4. Types of goods

   • Inelastic
     • Habit forming goods
       • cigarettes
     • Nescessities
   • elastic
     • any good with a substitute
   • Unit elasticity
     • A theory
     • Very unlikely

5. Total Revenue

   • All money recieved
   • Price X Quantity
   • If a good is elastic
     • A fall in price causes
       • A large rise in QD
         • Total revenue increases
   • Rectangle under graph
   • If good is inelastic
     • A fall in price causes
       • a proportionally smaller increase to PED
         • Total revenue decreases

6. Influences of PED

   • Luxury and necessity goods
   • Availability of Subsitutes
     • if substitutes are available
       • strong incentive to shift consumption
         • when price rises
       • product will be elastic
   • Proportion of income spent on product
     • if small, then PED will be inelastic
       • e.g. salt
     • If large, then PED will be elastic
   • Nature of product
     • Habit forming goods
       • If it is addictive
         • will be inelastic
         • e.g. alcohol
   • Durability of product
     • if it is long-lasting
       • elastic
         • can post-pone purchases
       • Furniture
     • if it needs to be replaces regularly
       • inelastic
       • e.g. milk
   • Length of time under consideration
     • takes time for consumers to adjust sending patterns
       • demand is more price elastic in the long run
   • Breadth of definition of a product
     • If a product is broadly defined
       • e.g. fruit
       • it is likely to be price inelastic
       • although if it is specific
         • apples
         • it is likely to be more elastic

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