Of Demand

• Price Elasticity of Demand


  Measures the responsiveness of quantity demanded to changes in price
• How to calculate Price Elasticity of Demand

  1. Percentage Change Method

  2. Midpoint Method
• Percentage Change Method


  (change in Q / Q) \* (P / change in P)
• Midpoint Method


  ((change in Q / Q average) \* (P average / change in P))
• Elastic coefficient


  A 1% change in the price will cause a Ed% change in quantity demanded
• Price Elasticity and Total revenue/total expenditure


  Effect of changes in price on total revenue is dependent on the price elasticity of the product
• Total revenue = Price \* quantity
• TR(TE) = P \* Q
• Perfectly Elastic

  Goods with perfect substitutes
• Perfectly Elastic


  • Reflects a perfectly competitive market where firms are price takers
  • Changes in price cause an infinite change in quantity demanded
  • If price changes, quantity demanded falls to zero
• Relatively Elastic


  Goods with many close substitutes
• Relatively Elastic


  • More easily respond to price and change to substitute
  • The change in quantity demanded is proportionally greater than the change in price
• Relatively Unitary Elastic


  Goods with some close substitutes
• Relatively Unitary Elastic


  • The change in quantity demanded is proportionally the same as the change in price
• Relatively Inelastic


  • The change in quantity demanded is proportionally less than the change in price
  • Goods with few close substitutes
  • Cannot be easily substituted, e.g. Petrol, cigarettes, bread, necessities
• Perfectly Inelastic


  • Goods with no substitutes, e.g. Insulin for diabetics
  • Changes in price cause no change in quantity demanded
  • No matter the price, consumers will always demand it regardless of price
• Elastic demand

  • When price increases, total revenue decreases
  • When price decreases, total revenue increases
• Inelastic Demand

  • When price increases, total revenue increases
  • When price decreases, total revenue decreases
• Unitary Elastic Demand

  No change in total revenue
• Elasticity and Taxes: Significance to tax revenue: Depending on the elasticity, tax revenue and the burden of the tax would vary
• Factors affecting PED: Availability of Substitutes: The more substitutes a good has, the more elastic it is. e.g. fast food, fruits etc.
• Factors affecting PED: The necessity of the product: The more a product is a necessity, the more the demand will be inelastic. This is because you don’t need it to survive, so if the price rises consumers demand less
• Factors affecting PED: Proportion of Income Spent: The greater the percentage of income a product is, the more likely it is to elastic. e.g. if a plane ticket price rises by 10%, demand will decrease more than if the price of a pencil increases by 10%
• Factors affecting PED: Time Period Considered: It often takes time for consumers to change their buying and consumption habits
• Factors affecting PED: Definition of the Market: The broader the definition of the market, the more substitutes are available, making demand more inelastic. Narrowly defined markets may have more elastic demand because there are more closer alternatives.
• Factors affecting PED: Cost of switching between products
• Factors affecting PED: Brand loyalty
• Factors affecting PED: Habitual consumption (addictions)
• If a good is price elastic in demand

  The amount of tax revenue is lower
• If a good is price elastic in demand

  There is a relatively large change in quantity demanded
• If a good is price inelastic in demand

  The amount of tax revenue is higher
• If a good is price inelastic in demand

  The burden of the tax falls more on the consumers
• If a good is price inelastic in demand

  There is a relatively small change in quantity demanded
• Price discrimination:

  • Price discrimination occurs when a seller charges different prices to different consumers for the same product or service, based on factors such as their willingness to pay, their age, or other demographic characteristics.
• Elastic: Quantity demanded of the product is relatively responsive to changes in price

  
• Inelastic: Quantity demanded of the product is relatively unresponsive to changes in price

  
• Perfectly Inelastic Ed = 0

  
• Relatively Inelastic. Absolute value of Ed < 1. e.g. 0.3

  
• Relatively Unitary Elastic Ed = 1. gradient = m = 1

  
• Relatively Elastic. Absolute value of Ed > 1. No negatives