# IB Micro Economics, PED (price elasticity of demand) and Firms

• luckyscar
In summary, a firm needs to have knowledge of price elasticity of demand in order to maximize profit and minimize lost profits due to concepts important to PED. Simultaneously, price and demand are closely related to a firm's potential revenue.
luckyscar

## Homework Statement

What is it: Practice Paper 1 b question for SL Economics IB

Question: Discuss why it may be important for a firm to have a knowledge of price elasticity of demand.

PS: It isn't stated explicitly to use a diagram, but my understanding is all Paper 1 questions need to be answered with diagrams to receive full points.

## Homework Equations

NA as far as I understand it. I don't think any equations are needed.

## The Attempt at a Solution

I was taught way back to use DEDE to answer everything. I always struggle with second d, diagram. (doing retakes, teaching was a while ago)

Define: Price Elasticity of demand - Price elasticity of demand is a measure of how much the quantity demanded of a product changes when there is a change in the price of the product.

Evaluate: PED is important for a firm to have knowledge on because it can help them to maximize profit and minimize lost profits due to the concepts important to PED. If a product has a higher price, it tends to have a more elastic demand because consumers are more concerned when the price of an expensive product rises than they are when the price of an inexpensive product rises. This concept helps a firm know the risks and advantages of changing a products price. Simultaneously, the relationship between price and demand is almost directly related to a firm's potential revenue. They want to find the optimal price so that the price * the quantity sold equals as high a number as it can. If a product has inelastic price elasticity, such as cigarettes, the firm can charge a higher price, without losing a huge amount of demand and potentially earning more money. On the other hand, a product such as a particular brand of bottled water, has a elastic price elasticity as a result of the high amount competition and tiny amount of variability in quality. So, in the case of the water bottle, a firm would be unable to realistically set a high price and make more money, for demand would go down too low.

My issue here is simply with the diagram and uncertainty on how much I need to cover in my answer. I assume I need to use a supply/demand curve, but what should I show on it? Just the shift in Q demanded in relationship to a change in price with the bottled water vs cigarettes? Would that be enough?

(I'm bad at drawing diagrams, I'd appreciate it if someone would draw an example of what I need, though that isn't 100% necessary.)

Last edited by a moderator:
luckyscar said:
... If a product has a higher price, it tends to have a more elastic demand because consumers are more concerned when the price of an expensive product rises than they are when the price of an inexpensive product rises.
While it's true that it TENDS that way, you can't overlook things like a very high cost AIDS drug. The demand is quite rigid ... get the drug or die.

Also with high end "obvious consumption" items, exclusivity can increase demand as prices go up which is of course the opposite of normal PED

## 1. What is price elasticity of demand (PED) and why is it important in economics?

Price elasticity of demand (PED) is a measure of how responsive the quantity of a good or service is to changes in its price. It is important in economics because it helps firms and policymakers understand how consumers will react to changes in prices, and therefore make better decisions about production and pricing strategies.

## 2. How is PED calculated and what do the values indicate?

PED is calculated by dividing the percentage change in quantity demanded by the percentage change in price. The resulting value can be either elastic (greater than 1), inelastic (less than 1), or unit elastic (equal to 1). Elastic demand means that a small change in price leads to a relatively large change in quantity demanded, while inelastic demand means that changes in price have a minimal impact on quantity demanded.

## 3. How does PED affect firms and their pricing decisions?

PED is an important factor for firms to consider when making pricing decisions. If a good or service has a relatively elastic demand, a decrease in price will lead to an increase in quantity demanded and therefore potentially higher profits. On the other hand, if a good or service has an inelastic demand, a price increase may not significantly affect quantity demanded, allowing the firm to charge a higher price and potentially increase profits.

## 4. How does PED differ for different types of goods?

PED can vary for different types of goods. For example, necessities such as food and water tend to have a more inelastic demand, as consumers will continue to purchase them regardless of price changes. On the other hand, luxury goods often have a more elastic demand, as consumers may be more likely to decrease their quantity demanded if the price increases.

## 5. How does PED relate to the concept of market power?

PED and market power are closely related. Market power refers to a firm's ability to influence the market price of a good or service. A firm with a relatively inelastic demand for its goods or services has more market power, as it can increase prices without losing a significant number of customers. This is why firms with monopolies or monopolistic competition tend to have more market power, as their goods or services may have relatively inelastic demand.

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