Price elasticity of demand (PED)
Law of demand tells us that P goes up Q goes down or P goes down and Q goes up. But it doesn’t give us any information about by how much Q changes compared to P. We want to know, using the PED, whether Q is changing by a lot compared to P, by a little bit compared to P or by the same rate as P. If %∆P<%∆Q, this good is called relatively elastic.
If %∆P>%∆Q, this good is called relatively inelastic. If %∆P=%∆Q, this good is called unit elastic.
Determinants of the PED
->Things that tell us what the PED is originally.
1) availability of substitutes –the more substitutes a good has, the easier it is for consumers to switch products if the price changes EX: if one brand of T-shirt is more expensive, choose another brand. In other words, for T-shirts, a relatively small increase in price will lead to a large drop in the quantity of T-shirts demanded. - If there are no easy substitutes, it will be inelastic demand. EX: electricity->no easy substitutes->inelastic->a price change will lead to a relatively small change in Q. power generater 2) Broad definition vs. narrow definition
Ex: broad: fruit ->few substitute->inelastic
Narrow: green grapes (seedless)->very many substitutes (any kind of fruit) -> elastic 3) necessities vs. luxuries
necessities ->no substitutes->inelastic
Luxuries->do not need them at all, so easy to avoid buying->elastic
4) length of time->short-term vs. long term
short-term: no time to make changes or adjustments after a P change->inelastic long-term: time to adjust->more elastic
5) Proportion of Income-cheap vs. expensive
cheap: low price as a % of income ->inelastic ex: pens
expensive: high price goods as a % of income->elastic Ex: diamond rings 6) Addiction: people with addictions have inelastic demand
EX: stealing from your mother to pay for heroin because the price went up.
How to calculate and interpret PED
PED=(percent change in quantity of good X demanded)/(percent change in price of good X)=% ∆Qx/%∆Px=Qx1-Qx0/(Qx0+Qx1)/2/(Px1-Px0)/(Px1+Px0)/2 PED is always negative=1/slope
In the elastic portion of the cure (ex: at P1) lowering the price can raise total revenue until unit elasticity is reached. In the inelastic portion of the curve(ex: at P2)increasing the price can raise total revenue until unit elasticity is reached.
CED=%∆Qx%∆Py ->quantity of good X, price of good Y(a substitute, complement of unrelated good to good X
Positive CED->x and y are substitutes CED>0
Negative CED->x and y are complements CED=<0
CED=0->no relationship between the products
Good A Q goes up 10% in response to good B P goes down15%
Good B Q goes down 10%
Good A P goes down 15%
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