What is the sensitivity of quantity demanded to changes in price known as?
Price elasticity of demand (PED)
PED measures how much the quantity demanded changes in response to a change in price.
Define price elastic demand.
A change in price results in a greater change in demand (elasticity > 1)
Goods with many substitutes tend to have price elastic demand.
Define inelastic demand.
A change in price results in a proportionately smaller change in demand (elasticity < 1)
Examples include basic necessities like rice and petrol.
When demand is elastic, what happens to sales revenue if the price rises?
Sales revenue falls
A price reduction leads to a large increase in sales volume and revenue.
When demand is inelastic, what happens to sales revenue if the price rises?
Sales revenue rises
A price cut produces a small increase in sales volume, leading to a fall in revenue.
List the factors that determine price elasticity of demand.
- Necessity of the product
- Competition for the same product
- Level of consumer loyalty
- Price of the product as a proportion of consumer’s incomes
These factors influence how consumers react to price changes.
What does income elasticity of demand (YED) measure?
Responsiveness of quantity demanded to changes in income
Businesses use YED to judge the effect of income changes on demand for their products.
If a rise in income leads to a relatively greater rise in quantity demanded, what is the YED value?
Positive and greater than 1
This typically indicates luxury goods.
What is the YED value if a rise in income leads to no change in quantity demanded?
Zero
This is characteristic of basic necessities.
What is the YED value if a rise in income leads to a fall in quantity demanded?
Negative
This indicates inferior goods, such as bread or bus transport.
What are necessities in terms of income elasticity?
Basic goods that consumers need to buy
Examples include food, electricity, and water.
What are luxuries in terms of income elasticity?
Goods that consumers like to buy if they can afford them
Examples include air travel and fashion accessories.
How does the price of a product relative to income influence income elasticity?
Cheap products tend to be income inelastic; expensive items tend to be income elastic
For example, pencils are income inelastic, while houses are income elastic.
What is the significance of income elasticity of demand to businesses?
- Affects demand during economic changes
- Helps in production planning
- Influences product switching
Understanding YED allows businesses to anticipate changes in demand based on income fluctuations.
