1.2 Price Elasticity of Demand
Indirect taxation on an inelastic product
-the revenue generated on an elastic product as consumers are more receptive to a change in price as it is an elastic product - demand will fall by a greater amount
If PES > 1
-the supply responds more than proportionally to a change in price. This supply is price elastic -This means the business can respond to the change in price -It is a shallower curve and intercepts through the price/vertical/y axis
If PES > ∞
-then supply is perfectly elastic and is infinitely responsive to a change in price i.e. if it went slightly up firms will produce all that they can, and if it went down they would produce nothing.
If PES = 0
-supply is said to be perfectly inelastic. This means that supply does not change at all when the price changes -This means there is a fixed amount of supply (concert tickets, Van Gogh paintings) and so the firm cannot respond
If PED = 1
-the percentage change in demand is exactly the same as the percentage change in price -then demand is said to be unit elastic
If PED is between 0 and 1
-the percentage change in demand is smaller than the percentage change in price -demand is inelastic. (milk, petrol, bread)
If PES = 1
-the percentage change in supply is the same as the percentage change in price), the supply is said to be unit elastic -Any supply curve that starts form the origin has unit elasticity whatever its steepness is
If PED = infinite
-then demand is perfectly elastic and is infinitely responsive to a change in price -if it went slightly down consumers will buy all that they can and if it went up they would buy nothing.
If PED > 1
-then demand responds more than proportionally to a change in price -the percentage change in demand is larger than the percentage change in price -This demand is elastic (jewellery)
3. Necessity or luxury
-A necessity is something that we class as not being able to live without -A luxury is something we would like but it is not essential -Something classed as a necessity has inelastic demand - electricity, water, staple foods, milk, petrol, medicine -Something classed as a luxury has elastic demand -The more essential a product, the more inelastic its demand is
Addiction
-A side note to this is if a consumer is addicted to a product -Despite being regarded as a luxury for many, products such as alcohol and cigarettes can be classed as necessities for some people and so have an inelastic PED -Often the concept of necessity and luxury is subjective.
Using PED to calculate total revenue
-Change in demand = PED x % change in price -% Change in price = % Change in demand/PED
5. Proportion of income spent
-The greater proportion of someone's income that is being spent on a product the more elastic the demand will be -For example, a consumer will be more responsive to a 10% change in price of a car then they would a 10% change in price of a sausage roll
What determines the PED co-efficient of a product?
-First, think about what would keep you buying a product even if the price of it went up? (i.e. it would be inelastic product for you)
PES coefficient
-If PES is between 0 and 1 (percentage change in supply is smaller than the percentage change in price) then supply is price elastic -This usually means the business does not or cannot respond quickly to change in the price -This would produce a relatively steep supply curve and passes through the quantity/horizontal/x axis
4. Ability to store stock
-If a business has lots of space to store stock, then it is likely to have a higher PES for its products. -This is because it can make the products and keep hold of them until price rises. -This is only likely to be a short-term thing as when the stock is then sold they may not be able to produce as much as they want to
Using PED
-If the PED of a product is known, the effect on demand of a change in price can be calculated
3. Level of spare capacity
-If the business has some spare capacity - i.e. it is not using all of it machines or able to offer overtime - then it can respond better to any desire to increase supply -This will make its PES more elastic. -If it has no or limited spare capacity, then it cannot fully increase its supply making PES more inelastic.
Income elasticity of demand (YED)
-Income elasticity of demand (YED) measures the relationship between a change in quantity demanded for a good and a change in real income - % change in demand% change in income -For YED, whether it is a + or - is important -Most products have a positive income elasticity of demand: As consumers income rises more is demanded at each price
PED and indirect taxes
-Indirect taxes are things such as VAT and GST -A consumer often does not realise they are paying it because it is incorporated in the price of a product -A government could raise revenue as the lower the PED co-efficient of the good taxed, the more it will earn. -An increase in indirect tax will shift the supply curve to the left (S1 to S2) -The shift in the curves equal to the amount of tax per unit of output - the same amount is supplied but the price charged to be willing and able to supply this amount must incorporate the new tax -A new equilibrium price and quantity point is created at the point where S2 crosses D
2. The closeness of substitutes
-It is one thing having a substitute, but the closeness of it must be considered as well -For example, if petrol went up then you could walk/cycle/get the bus but for many this is not an acceptable substitute so petrol remains inelastic -However, the difference between varieties of apples or trainers for example is much smaller and so they have greater "substitutability" - this means their PED is elastic -Be careful of the definitions used -Different variety of apples have close substitutability, but if using apples in the terms of fruit, they are not substitutable for oranges or pears or bananas -Same for trainers if classed as footwear with slippers or crocs -The narrower the definition the closer the substitutes
PES and the supply curve
-Like with PED and the demand curve, an elastic or inelastic supply curve will have differing levels of PES on it if it does not start at the origin -Therefore, when comparing PES of two different supply curves, only do so at a specific price.
What happens to revenue?
-PED is inelastic and a firm lowers its price= Total revenue decreases -PED is inelastic and a firm raises its price= Total revenue increases -PED is elastic and a firm lowers its price= Total revenue increases -PED is elastic and a firm raises its price= Total revenue decreases -PED is unit elastic and there is any change in price= Total revenue doesn't change
Determinants of PED
-Price elasticity of demand (PED) measures the responsiveness of demand for a product following a change in its own price
Price Elasticity of Demand
-Price elasticity of demand (PED) measures the responsiveness of demand for a product following a change in its own price -The formula is: Percentage change in quantity demanded/ percentage change in price -Percentage change = Difference/original𝑥 100 -Do not be confused whether the value is positive or negative, treat them both the same, (dropping the - value if it exists) -A rise in price will usually lead to a fall in demand -A fall in price will usually lead to a rise in demand -What PED shows is how much it will rise or fall
Price elasticity of supply (PES)
-Price elasticity of supply (PES) measures the responsiveness of the supply of a product following a change in its own price -PES=Percentage change in quantity suppliedPercentage change in price -PES is always positive -A rise in price will lead to a rise in supply -A fall in price will lead to a fall in supply -What PES shows is by how much it will rise or fall -If supply is elastic, firms can increase output without a rise in cost or time delay -If supply is inelastic, firms find it hard to change production in a given time period
Primary Commodities and Manufactured Products
-Primary commodities are goods that are derived from the land - farming, fishing, oil, coal etc. -Most of these products have low inelastic price coefficients -Conversely products that are manufactured tend to have higher price elastic coefficients
Why is this?
-Primary commodities are usually necessities with no substitutes -Manufactured goods are usually luxuries with lots of substitutes
Economic sectors
-Primary products have a relatively low YED (inelastic) -Secondary products will be slightly higher -Tertiary based products will have an even higher YED (elastic) -This means as an economy grows the relative size of the sectors -As society has more income the demand for income inelastic products grows more slowly than the demand -Alongside this, the demand for income elastic products goes quicker -Not a lot of income - will only buy necessities: food, clothing -Gains some more income - buy manufactured products: a TV, a car, a computer -Gets even more income - go out for meals, go to the cinema, go on holiday -This s usually a way of telling how economically developed a country is -The greater the share of its economy is made up of the tertiary/service sector the more developed it is -The greater the share of its economy I made up of the primary/agriculture sector, the less developed it is.
PES in Primary and Manufacturing
-Primary products will have a lower PES than manufactured products. -Agricultural products need to grow so farmers will at least need one harvest to respond to price changes. -For other primary products, such as oil and gas, the costs needed to mine additional quantities means that the businesses do not consider short term fluctuations, and wait for large excess demand levels before increasing production -So, although in the short run the PES of primary products is inelastic, it will become more elastic in the long run when there has been time to grow additional crops of mine additional resources.
PED and the Demand curve
-Straight line demand curves have varying levels of PED within them The part of the curve around the equilibrium point will have unit elasticity -The part of the curve above the equilibrium will have elastic PED -The part of the curve below the equilibrium will have inelastic PED -Above the equilibrium point suggests that the price is higher than it should be in a balanced market -This means consumers will be highly responsive to any change in price - it falls and they are much more likely to buy it as it is moving towards the equilibrium -It rises and they are much less likely to buy it as the majority will already feel it is too expensive -If it is below the equilibrium point, consumers will be less responsive to any change - inelastic PED -If the price goes up demand will change by a smaller percentage because cost consumers already feel they are still getting value for money even at the relatively higher price -If the price goes further down than demand will not significantly change either because at the original price most people have already bought the product -Therefore, the slope of the demand curve does not represent the PED -Although it will give a good idea of what to expect, the actual PED will vary throughout the curve - this is because it is based on % changes and will be influences by the values of the figures at each end of the curve -However, the slope of a demand curve is consistent reflects the actual change in raw terms
2. Mobility of factors of production
-The easier and quicker it is for a business to move its resources and production process between products, the greater the PES of that product.
1. The number of substitutes
-The more substitutes a product has, the more elastic its demand will be -This is because if a product like this raises its price then there are plenty of alternative options for a consumer to swap to -If there are few or no substitutes, then demand would be inelastic because consumers have little or no alternative and so would stick with the original product
Determinants of PES- 1. Time available
-The more time a business has the more elastic its supply will be. -With a very short time, they will not be able to respond to price changes - highly inelastic, PES = 0 -As time progresses, the business may be more able to adjust and so can raise supply slightly (inelastic, PES < 1) and then, eventually a lot (elastic, PES > 1)
XED > 0
-The price of good X increase then the demanded for good Y also increase -This occurs when the two products are substitutes
XED < 0
-The price of good X increases, then the demand for good Y falls -This occurs when the two products are complementary
Cross price elasticity of demand (XED)
-The price of subsite and complementary goods has an effect on the demand for a product -The cross-price elasticity of demand (XED) allows us to calculate this effect -Cross-price elasticity of demand measures the responsiveness of demand for a product following a change in the price of another product =XED = Percentage change in quantity demaned of good X/Percentage change in price of good Y -When looking at the XED co-efficient it is important to remember that unlike PED whether it is + or - is important
Graph with shallow demand curve
-The revenue generated on an elastic product is much lower as consumers are more receptive to a change in price as it is an elastic product - demand will fall by a greater amount -This means that governments are more likely to out indirect taxes on products with a low PED (inelastic products)
Graph with steep demand curve
-The shaded area represents the revenue generated by the government from this indirect tax -This is a demand for an inelastic product (as it is quite steep)
4. Time
-The shorter a consumer has to make a purchasing decision, the more inelastic their demand is -For example, if the price of a utility rises, the consumer would have to accept this is the short term, but over a longer period could choose to swap to a cheaper provider and so have more elastic demand
XED =0
-Then they are independent products -A change in the price in one will have no effect on the demand of the other
Applying PED- Total Revenue
-Total revenue (TR) is the amount of money received by a firm for selling a product -TR = P x Q
Application of YED
-Where there is an increase in economic growth, the income of society will increase -industries that have a higher YED (>1, luxuries) will ultimately benefit most from this situation. (restaurants, movies health care, foreign travel) -This means firms will want to know the YED of different industries in case they wish to expand and join those most likely to grow -Conversely, in times of recession (economy gets smaller) it is industries with a low YED (<1 necessities) that are less badly hit and so offer protection from the shrinking economy -Also, inferior goods (<0) may see increase in sales
If PED = 0
-demand is said to be perfectly inelastic. This means that demand does not change at all when the price changes (oxygen)
Normal necessities
-have a YED of between 0 and +1 -income increases by 10% demand increases by 4% then the income elasticity is +0.4 -Staple food products such as bread, vegetables and frozen foods
Inferior goods
-have a negative income elasticity of demand (<0) -This means that demand falls as income. -Typically, inferior goods exist where superior goods are available if the consumer has the money to be able to buy it
Luxury goods and services
-have an income elasticity of demand > +1 -demand rises more than proportionate to a change in income -Fine wines and spirits, high quality chocolates
Forumlas
PED = percentage change in quantity demanded/percentage change in price Slope of demand curve = change in quantity demanded/change in price
