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Factors That Affect Price Elasticity of Demand (PED)

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Miss Cummins

on 8 December 2016

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Transcript of Factors That Affect Price Elasticity of Demand (PED)

Factors That Affect Price Elasticity of Demand (PED)
PED measures the percentage/proportionate change in the quantity demanded for a good caused by the percentage/proportionate change in the price of the good itself.
What is PED?
A commodity that as a large number of uses will usually have a relatively elastic demand

Number of Alternative Uses the Good Has
The more durable the commodity, the more elastic the demand for it is likely to be in response to a change in its own price
The Durability of the Commodity
We have previously covered substitute goods . . .
The Availability of Close Substitutes
If the good in question is
the cheaper of the two goods which are in joint demand, then the demand for it is likely to be relatively inelastic
in response to changes in its own price

Complementary Goods
If the consumer know that the price of a commodity will fall, they will wait for the price to drop even further
Expectations for future change in price
Huge relevance to government/financial planning
This refers to the total income a person can spend on a particular good or service
Proportion of Income that is Spent on the Commodity
** In the long run, demand is more elastic as consumers have time to adjust to a change in price

The Length of Time Allowed for Adjustment to Price Change
Importance to Business People

If Barrys Tea went up by €0.25 consumers may switch to Lyons Tea
Most important factor influencing elasticity
The more substitutes that are available, the more elastic the demand
The closer the substitutability between goods, the more consumers will tend to switch from one substitute brand to another . . . PED will be greater
The use of one good involves the use of another good
Example
- if shoelaces are cheaper than shoes, then any change in the price of shoelaces will have very little effect on the demand for shoes
Luxury or necessity?
However
necessities
are essential for everyday life
Therefore,
PED for necessities will be relatively
inelastic

Its not essential that we possess
luxury
goods
They are wants and a discretionary expenditure
Therefore,
PED for luxury goods will be relatively
elastic
Example - 50% rise in price of sugar, unlikely to have a significant effect on demand
The greater proportion of income that is spent on a good, the
more elastic
the demand when the price changes
In general, as income increases, so does the quantity demanded of the goods
If products such as cars increase in price, it is likely that the public will extend the life of their existing model and postpone the purchase of a replacement
This means that the demand may not be very elastic on in the initial price reduction
Example 1
If the price of electricity rose by 80%, a consumer will economise on the use of appliances in the short run
The demand will be highly inelastic at first, but as time goes on it will be more elastic
In the long term, the consumer will consider substituting other forms of energy
Example 2
If the price of cigarettes goes up by €2 per pack, a smoker with very few substitutes will continue buying them
The price elasticity of cigarettes for that consumer becomes elastic in the long run
However, if that smoker realises that they cannot afford the extra €2, they may begin to quit over a period of time
This means that tobacco is inelastic because the change in price will not have a significant influence
Consumer Purchase Habits/Brand Loyalty/Advertising Effectiveness
The demand for the goods will be price inelastic
Increase in price will not cause them to consume less of the product or switch to an alternative
A consumer may become strongly attached to a particular product through habit or loyalty with that brand
Example - Sugar (many many uses)
Any increase in price may only result in a small fall in demand in each of the markets, total drop will be significant
Importance of Understanding Elasticity
Importance in Taxation Policy/ Minister for Finance
When the finance minister levies a tax on a certain commodity, he has to see whether the demand for that commodity is elastic or inelastic
If demand is inelastic - increase tax - more revenue
If demand is elastic - unlikely to increase tax - demand would decrease - less revenue
Demand is inelastic - likely to charge higher price and also increase total revenue
Demand for a good is elastic - lowering price of the good will increase sales and total revenue
Great importance

Use in International Trade
Marshall-Lerner Law (chp 28)
The effect of devaluation depends on the elasticity of the imports/exports
Exports become cheaper
Imports become more expensive
If €1 = £1 and the value of the euro falls against the sterling, how will this affect our imports and exports??
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