2.5

• Price Elasticity of Demand (PED)


  Reveals how responsive the change in quantity demanded is to a change in price

  
• Calculation of PED


  1. PED = % change in quantity demanded / % change in price

  2. % Change = (new value - old value) / old value x 100
• Worked example


  • Firm raises price from $10 to $15, sales fall from 100 to 40 units per day
  • PED = -60% / 50% = -1.2
• Interpreting PED values


  • 0 = Perfectly Inelastic
  • 0 to 1 = Relatively Inelastic
  • 1 = Unitary Elasticity
  • 1 to ∞ = Relatively Elastic
  • ∞ = Perfectly Elastic
• Determinants of PED


  • Availability of substitutes
  • Addictiveness of the product
  • Price of product as a proportion of income
  • Time period
• PED and Total Revenue


  To maximise revenue, firms should increase price of price inelastic products and decrease price of price elastic products

  
• Knowledge of PED is important for firms and governments
• PED of primary commodities vs manufactured products

  Primary commodities tend to be price inelastic, manufactured products tend to be price elastic
• Reasons for differences in PED (SPLAT)

  • Substitutes
  • Proportion of income
  • Luxury or necessity
  • Addictiveness
  • Time period
• SPLAT


  • Substitutes
  • Proportion of income
  • Luxury or necessity
  • Addictiveness
  • Time period
• A Comparison of the PED of Primary Commodities & Manufactured Products
• PED Factor


  • Primary Commodities - Inelastic (PED = 0−1)
  • Manufactured Goods - Elastic (PED = >1)
• Primary Commodities


  • Few substitutes as the required raw materials are defined by the product design
  • Each raw material component tends to be a fraction of the overall cost of the product which means demand if inelastic
  • Commodities are necessities as they are raw materials used in the production of goods
  • Certain raw materials are highly sought after by manufacturers e.g. iridium is a rare earth metal used to help create the famous Apple Macbook shell
  • The time period to grow or extract primary commodities is much longer than that required to manufacture products
• Manufactured Goods


  • Usually many substitutes e.g. different types of smart phones
  • Demand for manufactured goods such as cars or washing machines tend to take a larger proportion of the consumers income which makes the PED more elastic
  • Many manufactured goods tend to be luxuries e.g Swiss watches
  • Some manufactured goods can be very addictive e.g. cigarette's
  • Many products are manufactured in a relatively short time period
• Income Elasticity of Demand (YED)

  • Changes in income result in changes to the demand for goods/services
  • Reveals how responsive the change in quantity demanded is to a change in income
• Calculation of YED


  YED = % change in quantity demanded / % change in income
• Worked Example


  • A consumer's income rises from SG$ 100 to SG$ 125 a week. They originally consumed 12 bubble teas but this increased to 15 bubble teas a week. Calculate the YED of the bubble teas
• Interpreting YED Values


  • Positive YED = Normal good
  • Negative YED = Inferior good
• Engle Curves


  • Income is presented on the Y-axis and quantity demanded on the X-axis
  • The Value of YED Determines the type of good and Response to Changes in Income
• Value of YED


  • 0→1 = Necessity (Normal good, income inelastic)
  • YED > 1 = Luxury (Normal good, income elastic)
  • YED < 0 = Inferior Good (Quantity demanded decreases when income increases)
• Factors that Influence YED


  • YED is influenced by any factors in an economy which change the wages of workers
  • During a recession wages usually fall and demand for inferior goods rises while demand for luxury goods falls
  • During a period of economic growth and rising wages, demand for luxury goods increases while demand for inferior goods decreases
  • Other influences on income include minimum wage legislation, taxation, increased international trade
• The Importance of YED

  YED is crucial for firms as it helps them understand consumer behaviour, analyse markets, plan strategies, make informed investment decisions, and adapt to changes in the sectoral structure of the economy
• How Firms can use YED Effectively


  1. Understand consumer behaviour

  2. Adapt to changes in the sectoral structure of the economy
• Example


  • As income levels increase, consumers' preferences and concerns about environmental sustainability may lead to a higher demand for electric vehicle's (EVs)
  • The income elasticity of demand for EVs can help firms estimate the potential market growth and justify investment decisions
  • With a YED > 1, the EV sector is likely to experience rapid expansion as income levels rise, prompting firms to invest in manufacturing facilities, research and development, and charging infrastructure
  • This will further shift the sectoral structure of the economy, as the rising demand for EVs can result in the growth of related industries such as battery manufacturing, renewable energy, and charging networks