2.5 Elasticities of Demand (DP IB Economics: HL): Flashcards
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Define price elasticity of demand (PED).
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Define price elasticity of demand (PED).
Price elasticity of demand (PED) measures how responsive the quantity demanded of a good is to a change in its price.
What is the formula for PED?
PED = percentage change in quantity demanded ÷ percentage change in price.
True or False?
The value of PED is always negative.
True.
Because price and quantity demanded move in opposite directions; economists ignore the sign when interpreting the degree of elasticity.
What does price elastic demand tell us about consumers?
Price elastic demand means consumers are very responsive to price changes, as the percentage change in quantity demanded is more than proportional to the percentage change in price.
When demand is price , the percentage change in quantity demanded is less than proportional to the percentage change in price.
When demand is price inelastic, the percentage change in quantity demanded is less than proportional to the percentage change in price.
Define perfectly inelastic demand.
Perfectly inelastic demand (PED = 0) is where the quantity demanded is completely unresponsive to a change in price.
What PED value represents unitary elasticity?
Unitary elasticity has a PED value of 1, where the percentage change in quantity demanded is exactly equal to the percentage change in price.
What does the acronym SPLAT stand for?
The SPLAT determinants of PED are Substitutes, Price as a proportion of income, Luxury or necessity, Addictiveness and Time period.
Good availability of substitutes results in a value of PED, making demand relatively elastic.
Good availability of substitutes results in a higher value of PED, making demand relatively elastic.
True or False?
Luxury goods tend to have more price elastic demand than necessities.
True.
Luxuries are not essential so their demand is more elastic, while necessities are more inelastic because consumers have no choice but to buy them.
How does the addictiveness of a product affect its PED?
Addictiveness turns products into necessities, resulting in a low (relatively inelastic) value of PED.
Where on a straight-line demand curve is demand price elastic?
Demand is price elastic (PED > 1) at the top of the straight-line demand curve.
True or False?
A constant slope along a straight-line demand curve means elasticity is also constant.
False.
The slope is constant but elasticity changes along the curve; slope and elasticity are not the same thing.
Define the total revenue rule.
The total revenue rule states that to maximise revenue, firms should increase the price of products that are price inelastic in demand and decrease the price of products that are price elastic in demand.
To raise total revenue on a price inelastic product, should a firm raise or lower its price?
It should raise the price, because quantity demanded falls less than proportionately, so total revenue rises.
For a price elastic good, a firm can raise total revenue by its price.
For a price elastic good, a firm can raise total revenue by lowering its price.
True or False?
Lowering the price of a price inelastic good will increase a firm's total revenue.
False.
For a price inelastic good, total revenue is higher once the price is increased, not decreased.
Why might a government tax products with price inelastic demand?
Because consumers are less responsive to the price change, firms pass the tax on to consumers, so the government can raise tax revenue without harming firms too much.
Define price discrimination.
Price discrimination is charging different prices to different market segments — lower prices for some and higher prices for others — to maximise revenue.
Why is subsidising price elastic goods an effective policy?
Because there is a greater than proportional increase in quantity demanded, which is especially good for encouraging consumption of merit goods such as electric vehicles.
How does the PED of primary commodities compare with that of manufactured products?
The PED of primary commodities tends to be lower (more inelastic) than that of manufactured products.
Primary commodities tend to be price inelastic partly because they have few .
Primary commodities tend to be price inelastic partly because they have few substitutes.
True or False?
Manufactured goods tend to be more price elastic than primary commodities.
True.
They usually have many substitutes, take a larger proportion of income and are often luxuries.
How does the time period affect the PED of primary commodities?
The time period to grow or extract primary commodities is much longer than for manufactured products, contributing to their more inelastic demand.
Define income elasticity of demand (YED).
Income elasticity of demand (YED) measures how responsive the quantity demanded of a good is to a change in income.
What is the formula for YED?
YED = percentage change in quantity demanded ÷ percentage change in income.
True or False?
When interpreting YED, the sign of the value can be ignored.
False.
Unlike PED, the YED sign is integral: a positive value indicates a normal good and a negative value an inferior good.
Define inferior good.
An inferior good has a negative YED, meaning quantity demanded decreases when income increases.
Define normal good.
A normal good has a positive YED, meaning quantity demanded increases when income increases.
A necessity has a YED between 0 and 1, meaning it is income .
A necessity has a YED between 0 and 1, meaning it is income inelastic.
What YED value indicates a luxury good?
A luxury good has a YED greater than 1 (income elastic), so demand is relatively responsive to a change in income.
Define Engel curve.
An Engel curve is a model used to illustrate the relationship between income and the quantity demanded of a good.
What happens to demand for inferior goods during a recession?
During a recession wages usually fall, so demand for inferior goods rises while demand for luxury goods falls.
During a period of economic growth and rising wages, demand for luxury goods .
During a period of economic growth and rising wages, demand for luxury goods increases.
True or False?
A rise in the minimum wage can influence YED by changing workers' incomes.
True.
YED is influenced by any factors that change wages, such as minimum wage legislation, taxation and increased international trade.
Why is knowledge of YED important to firms?
It helps firms understand consumer behaviour and adapt to changes in the sectoral structure of the economy, informing strategy and investment decisions.
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