Glossary: Topic 5

Topic 5: Elasticities:

Elasticity = measure of responsiveness; measures how much something changes when there is a change in one of the factors that determines it.

Elasticity of demand = measure of how much the demand for a product changes when there is a change in one of the factors that determine demand:

  • Price elasticity of demand (PED) – measure of how much the quantity demanded of a product changes when there is a change in the price of the product:

Percentage change in quantity demanded of the product

Percentage change in price of product

  • Negative value indicates inverse relationship
  • Possible range values = zero to infinity
  • PED is zero = change in price of a product will have no effect on the quantity sold – perfectly inelastic
  • PED is infinity = if price changes even slightly, the demand falls to zero, perfectly elastic
  • Inelastic = value is less than one; change in price leads to a smaller change in demand; if a firm has an inelastic product, they should raise the price
  • Elastic = value is greater than one; change in price leads to a larger change in demand; if price is changed, the demand will fall more by comparison; if a firm has an elastic product, they should not raise the price of the product
  • Unit Elastic Demand = value is equal to one; a change in price will lead to a large, opposite, change in the quantity of demand; if the price is raised by a certain percentage, then the quantity demanded will fall by the same percentage, meaning the revenue will not change
  • As the price of a product goes lower, so does the value of elasticity; low priced products should have a more inelastic demand than high-priced products, because consumers are less concerned with the price of inexpensive products
  • Determinants of PED:
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  1. Number and closeness of substitutes: most important factor; more substitutes a product has, the more elastic it will be; e.g. many different brands of butter; oil has no substitutes and is inelastic
  2. The necessity of the product and how widely the product is defined: e.g. food is a necessary product so it should be inelastic; however there are many different types of food and many alternatives (going back to substitutes); necessity will change with tastes from consumer to consumer; drugs and alcohol tend to be inelastic
  3. The time period: a change in the price of ...

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