1.2.3 Price, Income and Cross Elasticities of Demand

Question 1

Price elasticity of demand

Answer 1

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

Question 2

Price elasticity of demand equation

Answer 2

percentage change in quantity/percentage change in

price %△Q/%△P

Question 3

Price elastic

Answer 3

• 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

Question 4

Price inelastic

Answer 4

• 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

Question 5

What is unitary is PED?

Answer 5

PED = 1

Question 6

Factors that affect PED

Answer 6

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

Question 7

How does the width of the market definition affect PED

Answer 7

the more the substitute, the higher the PED

Question 8

How does brand loyalty affect PED?

Answer 8

Brand loyalty = low PED

Question 9

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

Answer 9

If it is a necessity, it’s low PED

Question 10

What should PED for a normal good be?

Answer 10

Negative

Question 11

Importance of PED for a firm

Answer 11

helps firms decide whether to raise or lower price

Question 12

Importance of PED for indirect tax/subsidy

Answer 12

• 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

Question 13

Relationship between PED and total revenue

Answer 13

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

Question 14

Total revenue equation

Answer 14

total amount of goods x price

Question 15

Ceteris Paribus

Answer 15

the assumption that all other factors remaining constant

Question 16

Income elasticity of demand (YED)

Answer 16

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

Question 17

Income elasticity of demand (YED) equation

Answer 17

%△Q/%△ income

Question 18

Income elastic

Answer 18

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

Question 19

Luxury goods (in terms of income elasticity of demand)

Answer 19

Goods with higher positive value

Question 20

Inferior goods (in terms of income elasticity of demand)

Answer 20

Goods with negative YED values

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

Question 21

Income inelastic

Answer 21

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

Question 22

Example of an income inelastic good

Answer 22

necessities e.g water

Question 23

Cross price elasticity of demand (XED)

Answer 23

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

Question 24

Cross price elasticity of demand (xed) equation

Answer 24

%△QD of good Y/%△P of good X

Question 25

Complementary goods (XED)

Answer 25

- negative XED (downwards slope) | - if good X becomes more expensive, the quantity demanded for both good Y and X will fall

Question 26

Close complements (XED)

Answer 26

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

Question 27

Weak complements (XED)

Answer 27

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

Question 28

Substitutes (XED)

Answer 28

- positive XED (upwards slope) | - if good X becomes more expensive, consumers will switch to a different brand

Question 29

Close substitutes

Answer 29

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

Question 30

Weak substitutes

Answer 30

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

Question 31

Unrelated goods (XED)

Answer 31

XED is 0 (nothing changes)

Question 32

Negative XED

Answer 32

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

Question 33

Positive XED

Answer 33

- Substitutes (XED) | - if good X becomes more expensive, consumers will switch to a different brand

Question 34

Why are firms interested in XED?

Answer 34

- 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

Question 35

Advantages of brand loyalty

Answer 35

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.

Question 36

Consumer inertia

Answer 36

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