2.4 Price Elasticity of Demand (PED) (DP IB Economics: SL): 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) reveals how responsive the change in quantity demanded is to a change in price.
What is the formula for price elasticity of demand?
PED equals the percentage change in quantity demanded divided by the percentage change in price.
The PED value will always be negative, so economists ignore the sign and present the answer as a value.
The PED value will always be negative, so economists ignore the sign and present the answer as a positive value.
Define price elastic demand.
Price elastic demand is where the percentage change in quantity demanded is more than proportional to the percentage change in price, giving a PED value between -1 and ∞.
True or False?
A PED value closer to zero means demand is more price elastic.
False.
When the PED value is closer to zero, demand is becoming very inelastic, e.g. (-)0.1.
What is the PED value for 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.
Define price inelastic demand.
Price inelastic demand is where the percentage change in quantity demanded is less than proportional to the percentage change in price, giving a PED value between 0 and -1.
What does the acronym SPLAT stand for as the determinants of PED?
SPLAT stands for Substitutes, Price of the product as a proportion of income, Luxury or necessity, Addictiveness, and Time period.
Addictiveness turns products into necessities, resulting in a value of PED.
Addictiveness turns products into necessities, resulting in a low value of PED.
How does good availability of substitutes affect the value of PED?
Good availability of substitutes results in a higher value of PED, making demand relatively elastic.
How does a longer time period affect the PED of a product?
Over a longer period of time consumers can find substitutes, resulting in a higher value of PED (relatively elastic).
True or False?
PED is constant along a straight-line demand curve because its slope is constant.
False.
The slope is constant, but elasticity changes along the curve — demand is elastic at the top and inelastic at the bottom.
At the top of a straight-line demand curve, is demand price elastic or price inelastic?
At the top of a straight-line demand curve demand is price elastic (PED > 1).
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.
What happens to total revenue when the price of a price elastic good is decreased?
Total revenue is higher after the price is decreased, because there is a greater than proportional increase in quantity demanded.
A steep demand curve represents a price product.
A steep demand curve represents a price inelastic product.
True or False?
To maximise revenue, a firm should raise the price of a product that is price elastic in demand.
False.
For a price elastic product a firm should lower its price to maximise revenue; raising the price is the strategy for a price inelastic product.
Define price discrimination.
Price discrimination is when a firm charges lower prices to certain market segments and higher prices to others in order to maximise revenue.
Why can a government tax a price inelastic good without harming firms too much?
Because consumers are less responsive to price changes, firms can pass the tax on to consumers while quantity demanded falls only slightly.
What happens to quantity demanded when a government subsidises a price elastic good?
There is a greater than proportional increase in quantity demanded, which is especially useful for encouraging consumption of merit goods such as electric vehicles.
Define primary commodities.
Primary commodities are agricultural products or raw materials, such as those used in the production of manufactured goods.
What does the acronym SPLAT stand for?
SPLAT stands for Substitutes, Proportion of income, Luxury or necessity, Addictiveness and Time period — the factors that determine PED.
The PED of primary commodities tends to be than that of manufactured products.
The PED of primary commodities tends to be lower than that of manufactured products.
True or False?
Primary commodities typically have many substitutes, making their demand elastic.
False.
Primary commodities have few substitutes, because the required raw materials are defined by the product design, making their demand inelastic.
How does time period help explain why primary commodities are more price inelastic than manufactured goods?
The time period to grow or extract primary commodities is much longer than the time needed to manufacture products, making commodity demand less responsive to price.
Define manufactured products.
Manufactured products are processed goods such as washing machines, phones and cars, which tend to be more price elastic in demand than primary commodities.
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