elasticities

• Law of demand


  When price goes up, quantity demanded decreases. When price goes down, quantity demanded increases.
• Price elasticity of demand (PED)


  Measures the responsiveness of quantity demanded given a change in price
• Calculating PED


  PED = Percentage change in quantity demanded / Percentage change in price
• The PED value will always be negative due to the law of demand
• PED values


  • Greater than 1 = Demand is price elastic
  • Less than 1 = Demand is price inelastic
  • Equal to 1 = Demand is unit price elastic
  • Equal to 0 = Demand is perfectly price inelastic
  • Infinite = Demand is perfectly price elastic
• When price increases


  Quantity demanded decreases proportionately less than the price increase (price inelastic)
• When price decreases


  Quantity demanded increases proportionately more than the price decrease (price elastic)
• Factors affecting PED


  • Number of substitutes
  • Percentage of income spent
  • Whether it is a luxury or necessity
  • Whether it is addictive or habitual
  • Time period (short run vs long run)
• PED calculation example 1


  • Price of cigarettes increases from £4 to £5 (25% increase)

  Quantity demanded decreases from 150 to 135 (10% decrease)

  PED = -0.4 (price inelastic)
• PED calculation example 2

  • Price of sofa decreases from £1,000 to £800 (20% decrease)

  Quantity demanded increases from 2,000 to 3,800 (90% increase)

  PED = -4.5 (price elastic)
• Steep demand curve


  Indicates price inelastic demand
• Shallow demand curve


  Indicates price elastic demand
• Price elasticity of demand

  Crucial for businesses when making pricing decisions to increase their total revenue
• Total revenue


  P (price) times Q (quantity sold)
• If demand is price elastic

  Reducing price will increase total revenue
• If demand is price inelastic

  Increasing price will increase total revenue
• Elastic only irritates skin
• Elastic


  Opposite of inelastic
• Price changes


  Opposite effect on total revenue if demand is price elastic vs price inelastic
• If demand is price inelastic


  • Increasing price will decrease total revenue (because quantity demanded drops off significantly)
• If demand is price elastic


  • Reducing price will increase total revenue (because quantity demanded increases massively)
• If demand is price inelastic, increasing price will increase total revenue (because the decrease in quantity is small compared to the price increase)
• If demand is price inelastic, reducing price will decrease total revenue (because the increase in quantity is small compared to the price decrease)
• Proving concepts on diagrams


  1. Show revenue gain vs revenue lost when price changes

  2. Revenue gained is greater than revenue lost when demand is price elastic and price is reduced

  3. Revenue gained is greater than revenue lost when demand is price inelastic and price is increased
• Reducing price when demand is price elastic is in the interest of producers to increase total revenue
• Increasing price when demand is price inelastic is in the interest of producers to increase total revenue
• Price elasticity of supply (PS)


  Measures the responsiveness of quantity supplied given a change in price
• PS equation


  Percentage change in quantity supplied / Percentage change in price
• To convert numbers to percentage change: (Difference between two numbers) / Original number x 100
• PS will always be a positive number due to the law of supply
• Price elastic supply


  For any price change, the change in quantity supplied will be proportionally greater than the change in price
• Price inelastic supply


  When the price changes, the quantity supplied will change but proportionately less than the change in price
• Perfectly price inelastic supply


  Regardless of the change in price, quantity supplied will never change
• Perfectly price elastic supply


  Quantity supplied changes infinitely with any change in price
• Drawing supply curves based on price elasticity

  • Price inelastic supply = steep curve
  • Price elastic supply = shallow curve
  • Perfectly price inelastic = vertical curve
  • Perfectly price elastic = horizontal curve
• Determinants of price elasticity of supply


  • Production lag
  • Level of stocks
  • Spare capacity
  • Substitutability of factors of production
  • Time period (short-run vs long-run)
• Production lag


  The longer the production lag, the more price inelastic supply is
• Level of stocks


  The larger the level of stocks, the more price elastic supply is
• Spare capacity


  The more spare capacity, the more price elastic supply is
• Substitutability of factors of production


  The more substitutable, the more price elastic supply is