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    PPT - PED

    • If there was a 10% increase in the price of the goods below, would you stop purchasing them?
      • Favourite drink
      • Coffeee
      • Bus or Train fares
      • Apple iPhone
    Define the concept, and measurement, of price elasticity of demand
    • Price elasticity of demand measures the responsiveness of quantity demanded to changes in price #testanswer
      • Can be calculated by Percentage Change (Point Method 1) - $$Ed = \frac{%change \space in \space quantity \space demanded}{% change \space in \space price}$$
        • Also, the Midpoint Method - $$\frac{(Q_2-Q_1)/[(Q_2+Q_1)/2]}{(P_2-P_1)/[(P_2+P_1)/2]}$$
        • Point Method 2 $$\frac{\triangle Q}{Q}\times \frac{P}{\triangle P}$$
    Explain the determinants of price elasticity of demand
    • There are five main determinants/factors of PED
      • The availability of substitutes - if there are substitutes available, a good would be much more elastic
      • Whether the good is a necessity or a luxury - necessities would be inelastic, while luxuries would be elastic
      • Proportion of income spent - cheaper goods tend to be inelastic and unresponsive to price change, so higher income spent $\rightarrow$ more elastic
      • Time period considered - the more time to react to a price change, the more elastic a good gets. For example, for petrol, if the price increases you will likely immediately still need petrol, but in time you could change to other substitutes
      • The definition of the market - Narrower categories (fruits $\rightarrow$ bananas) produce more substitutes, and in this example there are many types of fruits. Narrower markets are more responsive.
    Distinguish between goods that are price elastic and price inelastic in demand
    • Two categories
      • Price Elastic products are ones where the quantity demanded of the product is relatively responsive to changes in price
        • Percentage change in quantity demanded $>$ percentage change in price
        • $|Ed|>1$
        • These products usually have relatively close substitutes
        • To graph, a very steep curve
      • Price Inelastic products are ones where the quantity demanded of the product is relatively unresponsive to changes in price
        • Percentage change in quantity demanded $<$ percentage change in price
        • $|Ed|<1$
        • These products cannot be substituted very well usually
        • To graph, a very flat curve
    Special Situations
    • $+$ Special Situations
      • Perfectly elastic - $Ed=\infty$, i.e changes in price cause an infinity change in quantity demanded
        • So, if price changes, quantity demanded falls to zero
        • Reflects a perfectly competitive market
        • To graph, a full flat curve
      • Perfectly inelastic - $Ed = 0$
        • Quantity demanded remains the same regardless of price
        • Reflects a market where there is fixed demand regardless of price - usually needs such as drugs.
        • To graph, a vertical line.
      • Unitary Elastic - $Ed = 1$
        • Changes in price equal changes in quantity demanded
    • Total Revenue is $P\times Q$
      • Graphically, this is the box of $PQ$, with a corner $(0,0)$
      • From here, we can calculate gains and losses (difference in boxes)
      • Effect of changes in price on total revenue is dependant on the price elasticity of the product;
        • For an inelastic good, price has a direct relationship to total revenue (inc. price = inc. total revenue)
        • For an elastic good, price has an inverse relationship to total revenue (inc. price = dec. total revenue)
        • Unitary goods have a constant total revenue
    Tax Revenue & Elasticity
    • Depending on elasticity, tax revenue and the burden of tax would vary
      • Tax incidence/burden of the tax: Who bears the majority of the tax
      • If a good is price inelastic in demand, the amount of tax revenue is higher and the burden of the tax falls more on the consumers
        • Relatively small change in quantity demanded
        • Think about cigarettes; it is inelastic and people will buy no matter what. The burden then falls on the consumers due to this.
      • If a good is price elastic in demand, the amount of tax revenue is lower and the burden of the tax falls more on the producers
        • Relatively large change in quantity demanded
    • Sample Question - What is the impact of a tax on a product that is inelastic in demand?
      • My response; When a tax is levied on an inelastic product, we can observe the supply curve shifting from $S$ to $S_{Tax}$. Because of this, the equilibrium shifts from $(Q_{1,}P_1)$ to $(Q_{2,}P_2)$. In doing so, the price that consumers pay becomes $Q_2$, and the amount that producers receive becomes $P_3$. We can then observe that tax revenue becomes $(P_2-P_{3}) \times Q_2$. The burden of tax is mostly placed on consumers, as the gap from $P_1$ to $P_2$ is greater than that from $P_1$ to $P_3$.
      • Ideal Response. Indirect tax will shift the supply curve to the left by the amount of the tax. Tje tax increases price to $P_2$, and increases the price that consumers now pay. Producers are now receiving $P_3$ in revenue. Quantity has fallen to $Q_2$. The tax revenue is $(P_2-P_{3}) \times Q_2$. The conumers bear a higher burden of the tax compared to the producers. There is a relatively small decrease in quantity.
    • Detailed below is a relatively inelastic product.

    InelasticCurve.svg
    And an elastic good (though without the axis labels...) ElasticDemandCurve.svg