Budget Curves

Classified in Economy

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PED= MEASURES THE RESPONSIVENESS OF DEMAND AFTER A CHARGE IN THE GOODS OWN PRICE

FORMULA FOR CALCULATING THE CO-EFFICIENT OF THE PRICE ELASTICITY OF DEMAND: % CHANGE IN QUANTITY DEMANDED/% CHANGE IN PRICE

IF PED=0, DEMAND IS PERFECTLY INELASTIC

IF PED IS BETWEEN 0 AND 1=%CHANGE IN DEMAND IS SMALLER THAN THE % CHANGE IN PRICE

IF PED=1 %CHANGE IN DEMAND IS THE SAME AS THE % CHANGE IN PRICE

IF PED>1, DEMAND RESPONDS MORE THAN PROPORTIONATELY TO A CHANGE IN PRICE

 WHAT FACTORS DETERMINE THE PED OF A PRODUCT?

NUMBER OF CLOSE SUBSTITUTES AVAILABLE FOR CUSTOMERS:

THE MORE SUBSTITUTES THERE ARE, THE MORE PRICE ELASTIC THE DEMAND

PRICE OF THE PRODUCT IN RELATION OF THE TOTAL INCOME:

WHEN THE % OF THIS BUDGET IS HIGH, DEMAND IS USUALLY MORE PRICE SENSITIVE

COST OF SUBSTITUTING BETWEEN DFFERENT PRODUCTS:

WHEN SUBSTITUTION/SWITCHING COSTS ARE HIGH, DEMAND WILL TEND TO BE PRICE ELASTIC

BRAND LOYALTY AND HABITUAL CONSUMPTION:

HIGH LEVELS OF BRAND LOYALTY MAKES DEMAND ESS PRICE ELASTIC

PERSUASIVE ADVERTISEMENT CAN MAKE DEMAND PRICE INELASTIC

DEGREE OF NECESSITY/LUXURY:

STANDARDS ASSUMPTION IS THAT NECESSITIES HAVE A LOWER PRICE ELASTICITY OF DEMAND WHEREAS LUXURIES ARE AN OPTIONAL SPEND.

INELASTIC DEMAND:

IF THE CO-EFFICIENT OF PRICE ELASTICITY OF DEMAND < 1, THEN DEMAND IS SAID TO BE PRICE INELASTIC.

FOLLOWING A CHANGE IN PRICE, THE TOTAL REVENUE EARNED BY THE PRODUCING FIRM WILL DEPEND ON THE PED FOR ITS PRODUCTS.

IF THE CO-EFFICIENT OF PED IS <1, A RAISE IN MARKET PRICE WILL LEAD TO AN INCREASE IN TOTAL REVENUE FOR THE SELLER OF THE PRODUCT.

ELASTIC DEMAND (PED>1):

IF THE COEFFICIENT OF PRICE ELASTICITY OF DEMAND >1, THEN DEMAND IS SAID TO BE PRICE ELASTIC.

IF DEMAND FOR A PRODUCT IS PRICE ELASTIC, A SUPPLIER STANDS TO GAIN EXTRA REVENUE IF THEY REDUCE THEIR PRICES.

THE CHANGE IN QUANTITY DEMANDED WILL BE PROPORTIONATELY HIGHER THAN THE REDUCTION IN PRICE.

PERFECTLY INELASTIC DEMAND (PED=0):

IF THE COEFFICIENT OF PRICE ELASTICITY OF DEMAND = ZERO, DEMAND IS PERFECTLY INELASTIC.

A PERFECTLY INELASTIC DEMAND CURVE IS AN EXTREMEM CASE.

IT IMPLIES THAT CONSUMERS ARE WILLING TO PAY ANY PRICE FOR THE PRODUCT.

IF SUPPLY FALLS, EQUILIBRIUM MARKET PRICE CAN RISE WITHOUT ANY CONTRACTION IN QUANTITY DEMANDED.

PERFECTLY ELASTIC DEMAND (PED=INFINITY)

IF THE COEFFICIENT OF PED=INFINITY, THEN DEMAND IS PERFECTLY ELASTIC – THERE IS ONE PRICE AT WHICH CONSUMERS ARE PREPARED TO PAY.

IF DEMAND IS PERFECTLY ELASTIC, A CHANGE IN MARKET SUPPLY WILL NOT LEAD TO ANY CHANGE IN THE EQUILIBRIUM PRICE.

THIS DEMAND CURVE APPLIES TO HIGHLY COMPETITIVE MARKETS WHERE NO SUPPLIER HAS ANY “PRICING POWER”


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