<2.7 PED>

--2.7.1 DEFINITION OF PED--

--INTRODUCTION--

We know the law of demand states that a rise in price leads to fall in the quantity demanded (Qd) and vice versa, however...
"How large ('Responsive') is the fall in Quantity demanded compared to the rise in price, and vice versa?"
In other words, if we raise price by 1%, what % will Qd fall? If we reduce price by 1% by how much % will Qd rise?

--PED: DEFINITION--

To answer this question we can use PRICE ELASTICITY OF DEMAND (PED) which measures the RESPONSIVENESS of QUANTITY DEMANDED of a good (In % change) to CHANGES IN the PRICE of the good (In % change).

--2.7.2 CALCULATION OF PED--

--PED: FORMULA--

Price elasticity of demand (PED) is the percentage change in quantity demanded for every 1% change in price. eg. if PED = 2 then for every 1% change in price Qd falls by 2%, so if price rises by 5%, Qd will fall by 10%.
Quick question, if the law of demand shows an INVERSE RELATIONSHIP between PRICE and QUANTITY DEMANDED, then what does this imply about the value of every PED?

--VALUES & TOTAL REVENUE--

--If PED < 1--

If the PED value is LESS THAN ONE it implies that the % Change in Qd (The responsiveness of Qd) is SMALLER than the % Change in Price. In this case we say that over the price range measured the PED is INELASTIC.
In terms of TOTAL REVENUE, when PED is inelastic Price and TR have an POSITIVE RELATIONSHIP, as if price rises TR rises and vice versa.

--If PED = 1--

If the PED value is EQUAL TO ONE it implies that the % Change in Qd (The responsiveness of Qd) is THE SAME as the % Change in Price. In this case we say that over the price range measured the PED is UNITARY ELASTIC.
In terms of TOTAL REVENUE, when PED is unitary elastic Price changes have NO IMPACT ON TR, as if price rises or falls TR stays unchanged.

--If PED > 1--

If the PED value is MORE THAN ONE it implies that the % Change in Qd (The responsiveness of Qd) is LARGER than the % Change in Price. In this case we say that over the price range measured the PED is ELASTIC.
In terms of TOTAL REVENUE, when PED is elastic Price and TR have an NEGATIVE RELATIONSHIP, as if price rises TR falls and vice versa.

--TASK--

If TES raised its study fees by 5% from $100 to $105, and quantity demanded fell by 10%, from 1000 to 900, what can we conclude about the elasticity of demand over this price range? How is total revenue impacted?

--DIAGRAMS--

--If PED < 1--

If the PED is INELASTIC the demand curve is often drawn STEEP, to illustrate how the % change in Qd is much smaller than the % change in price.

--If PED = 1--

If PED is UNITARY ELASTIC the demand curve is drawn as a RECTANGULAR HYPERBOLA to illustrate how the % change in Qd is the same as the % change in price.

--If PED > 1--

If the PED is ELASTIC the demand curve is often drawn FLATTISH, to illustrate how the % change in Qd is much larger than the % change in price.

--PAST PAPER MCQ--

--2.7.3 DETERMINANTS--

MORE INELASTIC

MORE ELASTIC

--FEW SUBSTITUTES--

The FEWER SUBSTITUTES a good (or service) has, the MORE INELASTIC is its demand. If the price of a good with few substitutes increases, consumers can't switch to other substitute products, therefore resulting in a relatively small drop in quantity demanded. e.g. petrol
Also if the good is ADDICTIVE, such as tobacco or alcohol, then there are few substitutes, and its demand as a whole will be inelastic.

--CLOSE SUBSTITUTES--

The MORE SUBSTITUTES a good (or service) has, the MORE ELASTIC is its demand. If the price of a good with many substitutes increases, consumers can switch to other substitute products, therefore resulting in a relatively large drop in the quantity demanded. E.g. Coke Cola & Pepsi

--BROAD DEFINITION--

The number of substitutes is also determined by how 'BROADLY THE GOOD IS DEFINED', for example, there are NOT many substitutes for 'FRUIT', making its PED relatively INELASTIC compared to a narrower definition of 'APPLES' which has many substitutes.

--NARROW DEFINITION--

The number of substitutes is also determined by how 'NARROW THE GOOD IS DEFINED', for example, there are many substitutes for 'APPLES', making their PED relatively ELASTIC compared to a more broader definition of 'FRUIT' which has less substitutes..

--NECESSITIES--

NECESSITES are goods or services we consider to be essential or necessary in our lives; and which we cannot do without them. The demand for necessities is usually INELASTIC. For example, the demand for medications/masks tends to be very inelastic because people’s health or life depend on them; therefore, quantity demanded is not very responsive to changes in price. The demand for food is also inelastic, because people cannot live without it.

--LUXURIES--

LUXURIES are goods or services we consider to be NON-essential in our lives; and which we can do without them. The demand for luxuries is usually ELASTIC. For example, the demand for diamonds tends to be very elastic because people do not rely on them for survival.

--LOW % OF INCOME--

The LOWER the proportion of one’s income needed to buy a good, the more INELASTIC the demand.
For example, SALT takes up a SMALL proportion of income, as such a 5% increase in price should result in only a very small fall in demand.

--HIGH % OF INCOME--

The HIGHER the proportion of one’s income needed to buy a good, the more ELASTIC the demand.
For example, BIG SCREEN-TVS takes up a LARGE proportion of income, as such a 5% increase in price should result in only a very small fall in demand.

--SHORT-TERM--

The SHORTER the time period in which a consumer makes a purchasing decision, the more INELASTIC the demand as they don't have the opportunity to consider whether they really want the good, and to get information on the availability of alternatives
For example, if there is an increase in the price of heating oil, consumers can do little to switch to other forms of heating in a short period of time, and therefore demand for heating oil tends to be inelastic over short periods.

--LONG-TERM--

The LONGER the time period in which a consumer makes a purchasing decision, the more ELASTIC the demand. As time goes by, consumers have the opportunity to consider whether they really want the good, and to get information on the availability of alternatives to the good in question.
As such we can say that the demand for oil is getting more and more ELASTIC over time as alternatives energy sources are being utilised more readily.

--TASK--

Using at least THREE of the determinants above explain why TES is relatively INELASTIC compared to 'Comebuy' bubble tea.

"TES is relatively INELASTIC in demand because firstly,....whereas Comebuy is more ELASTIC in demand because firstly..."

--2.7.4 PED & TOTAL REVENUE--

--WHAT IS TOTAL REVENUE?--

TOTAL REVENUE (TR) is the amount of money received by firms when they sell a good (or service), and is equal to the PRICE (P) of the good times and the QUANTITY (Q) OF THE GOOD SOLD. Therefore,

--TR = P × Q--

--TR ALONG A LINEAR DEMAND CURVE--

WE CAN SEE THAT AS THE PRICE IS LOWERED THE TOTAL REVENUE INITIALLY STARTS TO RISE, THEN PEAKS BEFORE FALLING, AND VICE-VERSA.
WE CAN SEE THAT THERE WILL ALWAYS COME A PRICE LEVEL BEYOND WHICH SELLING A LARGER QUANTITY AT A LOWER PRICE WILL GENERATE LESS TOTAL REVENUE THAN SELLING A SMALLER QUANTITY AT A HIGHER PRICE AND VICE VERSA.

--TOTAL REVENUE & PED--

WE CAN CLEARLY SEE THAT WHEN THE PED IS ELASTIC,...
- LOWERING THE PRICE RESULTS IN INCREASING TOTAL REVENUE, AND
- RAISING THE PRICE RESULTS IN DECREASING TOTAL REVENUE.
WE CAN CLEARLY SEE THAT WHEN THE PED IS INELASTIC,...
- LOWERING THE PRICE RESULTS IN DECREASING TOTAL REVENUE, AND
- RAISING THE PRICE RESULTS IN INCREASING TOTAL REVENUE.

--PRICING DECISIONS WITHIN ELASTIC SECTION--

-CHANGES IN TR WHEN DEMAND IS ELASTIC (PED > 1)-

If the price range is in the ELASTIC PORTION (PED >1)

-IF THE PRICE RISES TR FALLS.

-IF THE PRICE FALLS TR RISES.

--PRICING DECISIONS WITHIN INELASTIC PORTION--

-CHANGES IN TR WHEN DEMAND IS ELASTIC (PED > 1)-

If the price range is in the INELASTIC PORTION (PED <1)

-IF THE PRICE RISES TR RISES.

-IF THE PRICE FALLS TR FALLS.

--DIAGRAMS to ILLUSTRATE TR--

To illustrate an ELASTIC price change we use HIGHER PRICE RANGES.
To illustrate an INELASTIC price change we use HIGHER LOWER RANGES.

--2.7.5 SIGNIFICANCE--

--FIRMS PRICING DECISIONS--

For FIRMS it is important to know the PED value when they are CONSIDERING WHETHER TO RAISE or LOWER the PRICE of their product as it will help them determine the IMPACT on TOTAL REVENUE.
If PED = ELASTIC it should LOWER its price in order for TR to RISE, ceteris paribus.
If PED = INELASTIC it should RAISE its price in order for TR to RISE, ceteris paribus.
If PED = UNIT ELASTIC it should NOT RAISE or LOWER its price, ceteris paribus.

--GOV'T TAX REVENUES--

For GOVERNMENTS it is important to know the PED value when they are CONSIDERING WHETHER TO RAISE or LOWER the TAX on certain goods (E.g. Cigarettes or alcohol) as it will help them determine the IMPACT on the TAX REVENUE they can collect.
RULE: The more INELASTIC the GREATER the tax revenue collected.

(See 'Tax burden and elasticity')

--4-MARK TASK--

Choose ONE of the following:
- - Using an appropriate diagram explain whether or not you would advise a firm to LOWER ITS PRICE within its INELASTIC PRICE RANGE (4)
  - Using an appropriate diagram explain whether or not you would advise a firm to LOWER ITS PRICE within its ELASTIC PRICE RANGE (4)

<2.7 PED>

--INTRODUCTION--

--PED: DEFINITION--

--PED: FORMULA--

--If PED < 1--

--If PED = 1--

--If PED > 1--

--TASK--

--If PED < 1--

--If PED = 1--

--If PED > 1--

--PAST PAPER MCQ--

--FEW SUBSTITUTES--

--CLOSE SUBSTITUTES--

--BROAD DEFINITION--

--NARROW DEFINITION--

--NECESSITIES--

--LUXURIES--

--LOW % OF INCOME--

--HIGH % OF INCOME--

--SHORT-TERM--

--LONG-TERM--

--TASK--

--WHAT IS TOTAL REVENUE?--

--DIAGRAMS to ILLUSTRATE TR--

--FIRMS PRICING DECISIONS--

--GOV'T TAX REVENUES--

--4-MARK TASK--

--PAST PAPER QUESTIONS--

--MCQ TEST--