Leaving Cert Economics Elasticity: (a) (i) Define the categories of

Question

(a) (i) Define the categories of Price Elasticity of Demand (PED): elastic, inelastic and unit elastic.

Elastic Demand
The percentage / proportionate change in the price of the good causes a greater than percentage / proportionate change in quantity demanded of the good.

Inelastic Demand
The percentage / proportionate change in the price of the good causes a lesser percentage/proportionate change in the quantity demanded of the good.

Unitary Elastic Demand
The percentage / proportionate change in the price of the good is equal to the percentage / proportionate change in the quantity demanded of the good.

(ii) State three factors that affect PED and explain how each factor affects it.

1. The nature and availability of close substitutes
When a good has a close substitute and its price is increased, consumers may switch to the substitute, making demand elastic.

2. The proportion of income which is spent on the good
If a high percentage of income is spent on the good, even small price changes will significantly impact demand, making it more elastic.

3. The length of time allowed for adjustment to price changes
The longer the adjustment time, the more elastic the demand becomes, as consumers can find alternatives.

4. The durability of the good
Durable goods tend to have more elastic demand, as consumers can defer purchases in response to price changes.

5. Number of alternative uses the good has
If a good can be used for many purposes, consumers are likely to be sensitive to price changes, leading to more elastic demand.

(b) A consumer/motorist buys 20 litres of petrol when the price is £1.60 per litre. When the price increases to £1.70, as a result of an increase in carbon tax, the consumer buys 19 litres.
Calculate the consumer's Price Elasticity of Demand (PED) (Show all your workings).

PED = $ \frac{\text{Percentage change in quantity demanded}}{\text{Percentage change in price}} $

PED = $ \frac{\frac{19 - 20}{20}}{\frac{1.70 - 1.60}{1.60}} = \frac{-0.05}{0.0625} = -0.8 $

Is this demand for petrol price elastic or price inelastic? 
Demand for petrol is inelastic.

Outline the implication of your answer for government revenue.
An increase in the price of petrol will increase revenue for the government because the percentage increase in price will be greater than the percentage decrease in quantity demanded, resulting in increased tax revenue for the government.

(c) A firm is considering a change to its product's price. It conducts market research which reveals that the Price Elasticity of Demand (PED) for the product is -2.5.
Use this information to answer the following question:
(i) If the firm wishes to maximise total sales revenue, should it lower or raise the price of the product? Explain your answer.
This good is price elastic and a 1% reduction in price will cause a 2.5% increase in quantity demanded, which will increase total sales revenue.

(ii) In the case of an economy which is expected to remain in recession for the next five years, what, if any, will be the likely impact on the demand for the product? Explain your answer.
In a recession, demand for luxury goods, represented by the positive Income Elasticity of Demand (YED) of +4.5, will decrease significantly as consumers cut back on spending.

(a) (i) Define the categories of Price Elasticity of Demand (PED): elastic, inelastic and unit elastic - Leaving Cert Economics - Question 3 - 2014

Worked Solution & Example Answer:(a) (i) Define the categories of Price Elasticity of Demand (PED): elastic, inelastic and unit elastic - Leaving Cert Economics - Question 3 - 2014

Define the categories of Price Elasticity of Demand (PED): elastic, inelastic and unit elastic.

State three factors that affect PED and explain how each factor affects it.

Calculate the consumer's Price Elasticity of Demand (PED) (Show all your workings).

Is this demand for petrol price elastic or price inelastic? Outline the implication of your answer for government revenue.

If the firm wishes to maximise total sales revenue, should it lower or raise the price of the product? Explain your answer.

In the case of an economy which is expected to remain in recession for the next five years, what, if any, will be the likely impact on the demand for the product? Explain your answer.

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