Unit 8.2 Price elasticity of Demand

Elastic and Inelastic Demand Elastic demand means that demand changes by a greater percentage than the change in price. Ignoring the sign ( minus ), in this case, size of PED is more then 1, but less than infinity. ∞ > PED > 1 For elastic demand, Price and Total Revenue move in opposite directions. Means: Increase in Price → Decrease in Total Revenue (TR=PxQ) Decrease in Price → Increase in Total Revenue

Elastic demand is represented by shallow (flat) demand curve. Price Quantity demanded D D P Q P1 Q1

Inelastic demand means that demand changes by a smaller percentage than the change in price. Ignoring the sign, PED for inelastic demand is less then 1, but greater than zero. Means: 1 > PED > 0 For inelastic demand, Price and Total Revenue move in same directions. Means: Increase in Price → Increase in Total Revenue Decrease in Price → Decrease in Total Revenue

Inelastic demand is represented by steep (sharp) demand curve. Price Quantity demanded D D P Q P1 Q1

Factors determining the degree of Elasticity 1.Availability of close substitutes ( more substitutes, more elastic demand) 2.Proportion of income ( higher proportion of income spend on good, higher the elasticity of demand) 3.Necessity or luxury goods ( necessity-inelastic, luxury –elastic) 4.Addiction (cigarettes, alcohol, coffee-inelastic in demand) 5.Demand will be elastic if we can postpone purchasing of the product. If we have to buy it immediately, demand will be inelastic. 6.The more narrowly defined a product is, more elastic will be in demand ( demand for Nike will be more elastic than demand for sneakers in general)

Differences in PED The more time we have, demand will be more and more elastic. Elasticity of demand for same products will not be same in different countries. For example, luxury goods will be more inelastic in rich countries than in poor one. Necessities will be more inelastic in poor than in rich countries.

Degrees of Elasticity I Perfectly elastic demand PED= ∞ (change in price causes a complete change in quantity demanded) IIElastic demand ∞ > PED > 1 IIIUnit elasticity of demand PED=1 (percentage change in price results in an equal change in demand) IV Inelastic demand 1 > PED > 0 VPerfectly inelastic demand PED=0 (change in price does not causes any change in quantity demanded)

Changes in PED The higher the price is, demand will be more elastic. Price Quantity demanded Unit elasticity Inelastic demand Perfectly inelastic Elastic demand Perfectly elastic demand

The shift in demand curve to the right results in more inelastic demand. (if more people want to buy a product- shift of demand curve to the right, the less sensitive they are to the price). The shift of demand curve to the left results in more elastic demand. (decrease in demand-shift to the left, more sensitive consumers are to change in price).