Download Price Elasticity of Demand

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Price
Elasticity
of
Demand
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n
Elasticity = measure the responsiveness of one
variable to changes in another variable.
n
Price elasticity of demand measures the
responsiveness of demand to changes in price.
n
comparing the proportional changes in the price with
the proportional changes in the quantity demanded.
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Price elasticity of demand
coefficient
Economists express the relationship between the proportional
changes in price and demand in the form of a ratio or
coefficient. This is called the price elasticity of demand
coefficient.
PED
coefficient. =
% (proportional) change in the quantity demanded
% (proportional) change in the price
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PED is treated as if it were
positive although the
mathematical value is
usually negative.
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Price elastic
n
If a change in price causes the
quantity demanded to change
by a greater proportion then
PED >1.
n
If the PED is greater than one,
the good is price elastic.
Demand is responsive to a
change in price. If for example
a 15% fall in price leads to a
30% increase in quantity
demanded, the price elasticity
= 2.0
An elastic demand curve
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Price inelastic
n
If the quantity demanded
changes by a smaller proportion
than price then PED < 1.
n
If the PED is less than one, the
good is inelastic. Demand is not
very responsive to changes in
price. If for example a 20%
increase in price leads to a 5%
fall in quantity demanded, the
price elasticity = 0.25
An inelastic demand curve
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Unitary elasticity
n
If the quantity demanded
changes by an equal
proportion to price then:
PED = 1
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If the PED is equal to one, the
good has unit elasticity. The
percentage change in quantity
demanded is equal to the
percentage change in price.
Demand changes
proportionately to a price
change.
An unitary elastic demand
curve
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Perfect elasticity
n
If the value of the price elasticity
of demand for a product is
infinity, it is described as
perfectly elastic in
demand and the demand curve
will be completely horizontal
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If there is any change in price
and the demand falls to nothing
then the price elasticity is
infinity and described as
perfectly elastic. This is shown
by a horizontal demand curve as
for a given change in price
demand falls to zero.
An perfectly elastic demand
curve
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Perfect inelasticity
n
If the value of the price
elasticity of demand for a
product is zero, it is described
as perfectly inelastic
in demand and the demand
curve will be completely
vertical.
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If the increase in demand is
zero for any change in price
then the price elasticity is zero
and described as perfectly
inelastic. This is shown by a
vertical demand curve as for a
given change in price there is
no change in demand.
An perfectly inelastic demand
curve
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PED
Definition
Price elastic
PED > 1 % change in quantity
demanded is greater than
the % change in Price
Price inelastic
PED < 1 % change in Price is greater
than the % change in
quantity demanded
Unitary elasticity
PED = 1 % change in Price is equal
to the % change in quantity
demanded
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Determinants of PED
A good's PED is determined by numerous factors, these include:
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Number of substitutes: the larger the number of close substitutes for
the good then the easier the household can shift to alternative goods if
the price increases. Generally, the larger the number of close
substitutes, the more elastic the price elasticity of demand.
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Degree of necessity: If the good is a necessity item then the demand
is unlikely to change for a given change in price. This implies that
necessity goods have inelastic price elasticity's of demand.
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Price of the good as a proportion of income: It can be argued that
goods that account for a large proportion of disposable income tend to
be elastic. This is due to consumers being more aware of small
changes in price of expensive goods compared to small changes in
the price of inexpensive goods.