Unit 2.5 - Elasticities of Demand

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State the formula: perfectly price elastic (PED)HL

PED = ∞ perfectly price elastic

State the formula: perfectly price inelastic (PED)HL

PED = 0 perfectly price inelastic

State the formula: price elastic demandHL

PED > 1 price elastic demand

State the formula: unit elastic demandHL

PED = 1 unit elastic demand

PEDHL

Price Elasticity of Demand (PED) measures how much the quantity demanded of a good responds to a change in price. A PED greater than 1 indicates elastic demand, while a PED less than 1 indicates inelastic demand.

Unitary price elastic demandHL

A demand scenario where the percentage change in quantity demanded equals the percentage change in price, resulting in a price elasticity of demand (PED) value of 1. This indicates that total revenue remains unchanged when prices fluctuate, as the changes in demand compensate perfectly for the price alterations.

unit elastic demandHL

A type of demand where a percentage change in price results in an equal percentage change in quantity demanded, keeping total spending constant. This occurs when the price elasticity of demand (PED) value equals 1.0.

A condition where a small change in the price of a product results in a smaller proportionate change in the quantity demanded.

price inelastic demand

A situation where a relatively small change in the price of a product causes a larger percentage change in the quantity demanded.

price elastic demand

The measure of how quantity purchased changes in response to variations in external factors like price or income.

elasticity of demand

Relatively elastic

A measure of demand sensitivity to price changes, where a slight change in price leads to a large change in quantity demanded. This concept is crucial for understanding how consumers react to price fluctuations, indicating that demand is highly responsive.

Relatively inelastic

A measure of demand where changes in price have little impact on the quantity demanded. This indicates that consumers are less responsive to price changes, often due to a lack of substitutes or the nature of the product being essential.

Time to adjust

The duration consumers have to modify their purchasing habits or find alternatives in response to price changes. Longer adjustment periods tend to lead to more elastic demand as consumers can explore other options.

A pricing strategy that varies prices based on demand fluctuations.

Surge pricing

Charging different prices to different customers for the same product.

Price discrimination

The total income from selling goods, calculated as price times quantity.

Sales revenue

State the formula: Sales revenue

Sales revenue = P × Q Total revenue received by a firm equals the price per unit multiplied by the quantity sold.

Dynamic Pricing

A flexible pricing strategy that adjusts prices based on current market demands and conditions. Firms use this approach to optimize sales and revenue, particularly in industries with variable demand, like travel and entertainment.

manufactured products

Products such as electronics and vehicles that typically display higher price elasticity of demand. This is due to the availability of substitutes and lower necessity, making consumers more responsive to price changes compared to primary commodities.

surge pricing (dynamic pricing)

Surge pricing, also known as dynamic pricing, allows firms to adjust prices based on demand fluctuations. It is commonly used by airlines and ride-sharing services to maximize revenue during peak demand periods by charging higher prices when demand is inelastic.

tax incidence (tax burden)

Tax incidence, or tax burden, refers to how the burden of a tax is distributed between consumers and producers. In cases of inelastic demand, consumers tend to bear a larger share of the tax burden, as they are less responsive to price increases.

tax revenue

The income generated by governments through taxation on goods, particularly those with inelastic demand. This allows governments to impose higher taxes without significantly reducing consumption levels, thus increasing overall tax revenue.

The long-term increase in national output, often measured by real GDP.HL

Economic growth

YEDHL

A measure of how the quantity demanded of a good changes in response to changes in consumer income. It helps firms and governments understand market dynamics during economic fluctuations, particularly with luxury and inferior goods.

secondary sectorHL

The sector of the economy that involves the manufacturing of goods. It typically has a higher income elasticity of demand (YED) than the primary sector, meaning demand for manufactured goods increases more significantly as incomes rise.

sectoral changeHL

The shift in economic activity from one sector to another, often from primary to secondary and tertiary sectors, as a country develops. This change is influenced by income elasticity of demand (YED) and reflects changing consumer preferences.

tertiary sectorHL

The sector of the economy that provides services rather than goods. It tends to grow rapidly as real incomes rise, reflecting a higher YED value compared to the primary sector, as consumers demand more services.

A graphical representation showing how quantity demanded varies with changes in consumer income.

Engel curve

A product deemed essential for consumers, often leading to less responsive demand.

necessity

A situation in which the percentage change in quantity demanded is greater than the percentage change in income.

Income elastic demand

Goods that have a measure of responsiveness greater than 1, indicating that demand increases more than proportionally as income rises.

Luxuries

The amount of money consumers can spend after taxes and inflation.

Real disposable income

When the percentage change in quantity demanded is less than the percentage change in consumers’ real income, indicating a low responsiveness to income changes.

Income inelastic demand

State the formula: If YED

If YED = -0.25 and income increases by 3%, percentage change in demand = -0.25 × 3% = -0.75% Worked calculation used in an exam practice question to find the percentage change in demand for an inferior good.

State the formula: YED

YED = %ΔQ / %ΔY YED = 5% ÷ 10% = +0.5 YED = 10% ÷ 6% = +1.67

Consumer Behavior

The examination of the influences and patterns in how individuals select, purchase, use, and dispose of goods and services, which is critical for understanding demand elasticity and market trends.

Essential Products

Necessities that consumers buy to meet basic needs, such as food and household items. These products typically have a YED value of less than 1, indicating that demand is relatively unresponsive to changes in income.

Luxuries (superior goods)

Luxuries, also known as superior goods, are products with a YED greater than 1, indicating that demand increases more than proportionately as consumer income rises. Unlike necessities, which have a lower YED, luxuries are often non-essential items that consumers desire more of when they can afford them.

Luxury Products

Goods and services that have a YED value greater than 1, indicating that demand increases more than proportionately as consumer incomes rise. Examples include designer clothing and high-end vacations.

Negative YED

A characteristic of inferior goods, where demand decreases as consumer income rises. This inverse relationship indicates that consumers tend to opt for higher-quality alternatives as their financial situation improves.

Positive YED

The behavior of normal goods, where demand increases with rising consumer incomes. These goods can be further classified into necessities and luxuries, indicating varying degrees of responsiveness to income changes.

Substitution (between inferior and superior goods)

The pattern where consumers move from inferior goods to superior goods as their income rises. This reflects a shift in preferences towards higher-quality products as financial resources increase.

Products that are not essential and often more price elastic.

luxury goods

State the formula: PED at midpoint of linear demand curve

PED at midpoint of linear demand curve = 1 On a straight-line demand curve the value of PED is equal to 1 at the mid-point; above the midpoint PED > 1 and below the midpoint PED < 1.

State the formula: PED → ∞ at price-axis intercept; PED → 0 at quantity-axis intercept

PED → ∞ at price-axis intercept; PED → 0 at quantity-axis intercept At very high prices where quantity demanded approaches zero, PED tends to infinity; at very low prices where price approaches zero, PED tends to zero.

State the formula: Total revenue

Total revenue (TR) = P × Q Total revenue is the product of price per unit and quantity sold; used to compare revenue before and after price changes.

Degree of necessity

A determinant of price elasticity indicating how essential a product is to consumers. Necessities tend to have inelastic demand, while luxuries are more elastic, as consumers can forego non-essential items if prices rise.

Elastic demand

A situation where a small change in price results in a large change in quantity demanded. This typically occurs for products with many substitutes or when consumers can easily switch to alternatives.

Inelastic demand

A condition where a change in price leads to a smaller percentage change in quantity demanded. This often applies to essential goods with few substitutes, making consumers less sensitive to price increases.

Mid-point of a linear demand curve

The specific point on a linear demand curve where the price elasticity of demand (PED) equals 1.0, indicating that percentage changes in price and quantity demanded are equal, marking the transition between elastic and inelastic demand.

Price (P) × Quantity (Q)

Price (P) multiplied by Quantity (Q) represents total revenue. Understanding this relationship helps firms determine how changes in price affect their overall revenue, particularly in relation to the price elasticity of demand.

Proportion of income

A determinant of price elasticity that refers to the share of a consumer's income spent on a good or service. Products that take up a larger proportion of income tend to have more elastic demand, as consumers are more sensitive to price changes.

Time period

A determinant of price elasticity of demand that emphasizes how demand becomes more elastic over extended durations. As consumers have more time to find alternatives or adjust their preferences, their response to price changes increases.

Unitary elasticity

A scenario where the percentage change in quantity demanded is equal to the percentage change in price, resulting in no change in total revenue. This balance indicates a specific relationship between price and demand.

addictive goods

Products that create a dependency in consumers, such as tobacco or alcohol, leading to relatively inelastic demand. Consumers are less responsive to price increases because they feel compelled to continue purchasing these goods.

customer loyalty

The tendency of consumers to continue buying the same brand or product over time, which can reduce the elasticity of demand. High customer loyalty often leads to less sensitivity to price changes due to the perceived value of sticking with a preferred brand.

Raw materials or basic products used directly by consumers or in production.HL

Primary commodities

manufactured goodsHL

A category of products that typically have a price elastic demand due to the availability of substitutes and their non-essential nature, making consumers more sensitive to price changes compared to primary commodities, which are often inelastic due to fewer substitutes.

A measure of how responsive the quantity bought of a product is to a change in its own price, found by dividing the percentage change in quantity demanded by the percentage change in price.

price elasticity of demand (PED)

A movement along a demand curve due to a price change.

A change in quantity demanded

State the formula: % change

% change = (New figure – Old figure) / Old figure × 100 To calculate the percentage change between two numbers use the difference divided by the old figure, times 100.

State the formula: Price elasticity of demand

PED = %ΔQ / %ΔP Price elasticity of demand is calculated as percentage change in quantity demanded divided by percentage change in price.

State the formula: percentage change between two numbers

Percentage change = (New figure – Old figure) / Old figure × 100 This formula is used to calculate the percentage change between two numbers.

Percentage change

A calculation used to measure the responsiveness of quantity demanded in relation to a change in price. It is expressed as the ratio of the change in quantity demanded to the change in price, providing insight into price elasticity.

Demand that changes less than the percentage change in earnings.

Income inelastic

Demand that changes more than the percentage change in earnings.

Income elastic

Measures how quantity demanded changes with consumer income variations.

Income elasticity of demand, or YED

The situation where demand remains unchanged regardless of changes in income.

Perfectly income inelastic

State the formula: Income elasticity of demand

YED = (percentage change in quantity demanded) / (percentage change in income) Income elasticity of demand is the ratio of the percent change in quantity demanded to the percent change in consumer income.

Income elastic (YED > 1)

Income elastic demand is characterized by a YED greater than 1, meaning that quantity demanded changes by a larger percentage than income. These goods are typically luxuries, such as designer clothing or overseas holidays, which consumers buy more of as their income rises.

Income inelastic (YED between 0 and 1)

Income inelastic demand occurs when the income elasticity of demand (YED) is positive but less than 1, indicating that quantity demanded changes by a smaller percentage than income. These goods are often necessities, such as basic food or essential transport, reflecting limited responsiveness to income changes.