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Theme 1 > 1.2.3 Price, Income and Cross Elasticities of Demand > Flashcards

1.2.3 Price, Income and Cross Elasticities of Demand Flashcards

1
Q

Price elasticity of demand

A

a way for economists to sense how sensitive the quantity (of a good/service) is to a change in price

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2
Q

Price elasticity of demand equation

A

percentage change in quantity/percentage change in

price %△Q/%△P

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3
Q

Price elastic

A
  • the quantity changes a lot for a given price change (is relatively responsive to price change)
  • has a shallow demand curve
  • PED>1
  • percentage change in quantity is more than price change
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4
Q

Price inelastic

A
  • the quantity doesn’t change much for a given price change (is relatively unresponsive to price change)
  • has a steep demand curve
  • PED<1
  • percentage change in quantity is less than price change
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5
Q

What is unitary is PED?

A

PED = 1

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6
Q

Factors that affect PED

A
  • brand loyalty
  • price of good itself (absolute price)
  • ability to postpone consumption (necessity)
  • width of the market definition
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7
Q

How does the width of the market definition affect PED

A

the more the substitute, the higher the PED

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8
Q

How does brand loyalty affect PED?

A

Brand loyalty = low PED

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9
Q

How does the ability to postpone consumption (necessity) affect PED?

A

If it is a necessity, it’s low PED

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10
Q

What should PED for a normal good be?

A

Negative

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11
Q

Importance of PED for a firm

A

helps firms decide whether to raise or lower price

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12
Q

Importance of PED for indirect tax/subsidy

A
  • It’s important to consider PED when imposing a tax
  • Govt can impose higher taxes on goods with inelastic demand vice versa
  • If they don’t and the prices rise, but there’s no change in real income consumers won’t be willing to pay
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13
Q

Relationship between PED and total revenue

A
  • Demand elastic
  • Price decline = total revenue increase
  • Demand inelastic = elasticity is the same
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14
Q

Total revenue equation

A

total amount of goods x price

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15
Q

Ceteris Paribus

A

the assumption that all other factors remaining constant

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16
Q

Income elasticity of demand (YED)

A

a measure of the responsiveness of demand following a change in income

17
Q

Income elasticity of demand (YED) equation

A

%△Q/%△ income

18
Q

Income elastic

A
  • the change in demand is more responsive than the change in income
  • YED>1
  • luxury goods
19
Q

Luxury goods (in terms of income elasticity of demand)

A

Goods with higher positive value

20
Q

Inferior goods (in terms of income elasticity of demand)

A

Goods with negative YED values

- an increase in income will lead to a fall in demand

21
Q

Income inelastic

A
  • the change in demand is less responsive than the change in income
  • YED<1 (but positive e.g decimals )
  • normal good
22
Q

Example of an income inelastic good

A

necessities e.g water

23
Q

Cross price elasticity of demand (XED)

A

a measure of the responsiveness of demand for one good following the change in price of another good

24
Q

Cross price elasticity of demand (xed) equation

A

%△QD of good Y/%△P of good X

25
Q

Complementary goods (XED)

A
  • negative XED (downwards slope)

- if good X becomes more expensive, the quantity demanded for both good Y and X will fall

26
Q

Close complements (XED)

A

a small fall in the price of good X, leads to a large increase in the quantity demanded of good Y

27
Q

Weak complements (XED)

A

a large fall in the price of good X leads to only a small increase in the quantity demanded of good Y

28
Q

Substitutes (XED)

A
  • positive XED (upwards slope)

- if good X becomes more expensive, consumers will switch to a different brand

29
Q

Close substitutes

A

a small increase in the price of good X leads to a large increase in the quantity demanded of Y

30
Q

Weak substitutes

A

a large increase in the price of good X leads to a smaller increase in the quantity demanded of good Y

31
Q

Unrelated goods (XED)

A

XED is 0 (nothing changes)

32
Q

Negative XED

A
  • Complementary goods

- if good X becomes more expensive, the quantity demanded for both good Y and X will fall

33
Q

Positive XED

A
  • Substitutes (XED)

- if good X becomes more expensive, consumers will switch to a different brand

34
Q

Why are firms interested in XED?

A
  • It allows them to see how many competitors they have

- So they’re less likely to be affected by price changes of other firms, if they are selling complementary goods

35
Q

Advantages of brand loyalty

A

Brand loyalty makes demand for a firm’s products more price inelastic = allows a business to set prices higher & extract consumer surplus turning it into producer surplus.

36
Q

Consumer inertia

A

the tendency of some customers to buy or continue buying a product, even when superior options exist

Theme 1 (19 decks)

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