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3. (a) (i) Explain the term Price Elasticity of Demand (PED) - Leaving Cert Economics - Question 3 - 2019
Question 3
3. (a) (i) Explain the term Price Elasticity of Demand (PED). (ii) Outline four factors that affect the PED for a good or service, providing examples to support your... show full transcript
Worked Solution & Example Answer:3. (a) (i) Explain the term Price Elasticity of Demand (PED) - Leaving Cert Economics - Question 3 - 2019
Step 1
Explain the term Price Elasticity of Demand (PED).
Answer
Price Elasticity of Demand (PED) measures the responsiveness of quantity demanded to a change in the price of the good. Specifically, it reflects how much the quantity demanded changes in percentage terms in response to a one percent change in price. For example, if a product has a PED of 2, then a 1% increase in price would lead to a 2% decrease in quantity demanded, indicating that the demand is elastic.
Step 2
Outline four factors that affect the PED for a good or service, providing examples to support your answer.
Answer
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Durability: The longer a product lasts, the less sensitive consumers might be to price changes. For instance, consumers may not rush to buy a car simply because its price decreased, as it remains functional and can be used longer.
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Availability of Close Substitutes: If a product has many substitutes, the demand for it tends to be more elastic. For example, if the price of a specific brand of soda rises, consumers might easily switch to another brand.
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Luxury vs. Necessity: Luxury goods usually have more elastic demand. For instance, a hike in luxury hotel prices may deter consumers, whereas essential goods, such as basic groceries, tend to have inelastic demand.
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Percentage of Income Spent: Goods that take up a larger proportion of a consumer's income tend to have more elastic demand. For example, if a consumer must spend a significant percentage of their income on rent, they may become very sensitive to any price increase in housing.
Step 3
Using your knowledge of PED, explain which figure above is more likely to correspond to holiday-makers and which to business travellers.
Answer
Holiday-makers typically have a PED of 2.4, indicating their demand is elastic; they are more responsive to price changes. Business travellers, exhibiting a PED of 0.1, demonstrate inelastic demand since their travel needs may not change significantly with price fluctuations. Thus, the figure of 0.1 is likely for business travellers, while 2.4 is more appropriate for holiday-makers.
Step 4
Explain, with the aid of diagrams, the difference between price elastic demand and price inelastic demand.
Answer
Price elastic demand is characterized by a greater percentage change in quantity demanded than in price changes, represented by Diagram 2, where a small increase in price leads to a large decrease in quantity. In contrast, price inelastic demand reflects a smaller percentage change in quantity demanded compared to the price change, as shown in Diagram 1 where the demand curve is steeper. In summary, when PED < 1, demand is inelastic; when PED > 1, demand is elastic.
Step 5
Explain how knowledge of PED is useful when analysing the effect of price changes on total revenue for an airline.
Answer
Understanding PED helps airlines predict how changes in ticket prices will influence total revenue. For inelastic demand (like business travellers), increasing prices may lead to higher total revenue, as quantity demanded drops less proportionately. Conversely, for elastic demand (like holiday-makers), raising prices could decrease total revenue, as the demand will significantly decrease. Thus, airlines can strategize pricing to optimize revenue based on the elasticity of their different passenger categories.