Price elasticities of demand

• What is price elasticity of demand and its formula?

  Price elasticity of demand reveals how responsive the change in quantity demanded is to a change in price

  PED = percentage change of QD in good X / percentage change in price of good Y
• What does it mean when the price elasticity of demand is perfectly inelastic?

  Value = 0

  The QD is completely unresponsive to a change in price

  
• What does it mean when the price elasticity of demand is inelastic?

  Value= PED<1

  The %∆ in QD is less than proportional to the %∆ in Price

  
• What does it mean when the price elasticity of demand is unitary elastic?

  Value = 1

  • The % ∆ in QD is exactly equal to the %∆ in P

  
• What does it mean when PED is elastic

  Value = PED >1

  • The %∆ in QD is more than proportional to the %∆ in P (e.g. luxury products)

  
• What does it mean when PED is perfectly elastic

  Value = infinity

  • The %∆ in QD will fall to zero with any %∆ in P (highly theoretical elasticity)

  
• If a product is price elastic, what should a firm do to maximise revenue?

  • If their product is price elastic in demand, they should decrease their prices
  • When a good/service is price elastic in demand, there is a greater than proportional increase in the quantity demanded to a decrease in price
  • A small decrease in price leads to a larger increase in QD
  • TR is higher once the price has been decreased
  • (P2xQ2)>(P1xQ1)

  
• If a product is price inelastic, what should a firm do to maximise revenue?

  • If their product is price inelastic in demand, they should raise their prices
  • When a good/service is price inelastic in demand, there is a smaller than proportional decrease in the quantity demanded to an increase in price
  • A large increase in price leads to a smaller decrease in QD
  • TR is higher once the price has been increased
  • (P2xQ2)>(P1xQ1)

  
• What is total revenue?

  Price x quantity
• What is price discrimination?

  • When firms choose to use price discrimination to maximise their revenue
  • They lower their prices for elastic sections of their market e.g. off peak train travel
  • They increase prices for inelastic sections of their market e.g. peak hour train trave
• What are the factors that influence PED?

  • Availability of substitutes
  • Addictiveness of the product 
  • Price of product as a proportion of income
  • Time period
  • necessity of good/service
• How does availiabilty of subsitutes affect PED?

  • Availability of substitutes: good availability of substitutes results in a higher value of PED (relatively elastic)
• How does addictiveness of the product affect PED?

  • Addictiveness of the product: addictiveness turns products into necessities, resulting in a low value of PED (relatively inelastic)
• How does price of product as a proportion of income affect PED?

  • Price of product as a proportion of income: the lower the proportion of income the price represents, the lower the PED value will be. Consumers are less responsive to price changes on cheap products (relatively inelastic)
• How does time period affect PED?

  • Time period: In the short term, consumers are less responsive to price increases, resulting in a low value of PED (relatively inelastic). Over a longer period of time, consumers may feel the price increase more and will then look for substitutes, resulting in a higher value of PED (relatively elastic)