1.2.3 Price, Income And Cross Elasticities Of Demand ✅ Flashcards
What is the law of demand?
When there is an increase in price quantity demanded will fall.
What is PED?
Price elasticity of demand reveals how responsive is demand to a change in price.
Give the PED calculation
P1/QD1 X change in QD/change in p
What do economists ignore when working out the PED?
The negative sign (will always be negative).
What are the five PED values? And what are their PEDS?
Perfectly inelastic = 0 (more theoretical)
Relatively inelastic = 0 to 1
Unitary elastic = 1
Relatively elastic = 0 to infinity
Perfectly elastic = infinity (more theoretical)
What is the difference between an elastic and inelastic graph?
Elastic are more flat and inelastic and more vertical.
What are the characteristics of a product which is elastic to demand?
- luxury good (takes up big chunk of disposable income).
- competitive market (more substitutes).
- frequently bought (more likely to compare prices).
What are the characteristic of an inelastic good?
- short-term (demand usually more inelastic here eg like fuel).
- necessity.
- addictive (more accommodating to higher prices).
- few substitutes.
- product is a small percentage of income (rich and money doesn’t matter).
- brand loyalty.
What is a positive of an inelastic good to the producers?
Bigger revenue. (Prices can be increased).
What is YED?
Income elasticity of demand is the responsiveness of demand to a change in income.
How do you calculate YED?
Y1/QD1 X change in QD/change in income
What determines the type of product a good is when YED is measured?
The symbol.
What does a negative YED mean?
It is an inferior good. (Income increases demand decreases - look for better options).
What does it mean when YED is positive? Give two types?
It is a normal good (demand increases when income increases).
Normal necessity good = 0 to 1
Normal luxury good = 1+
What type of good is income inelastic?
Normal good (income in elastic).
What good is considered income elastic?
- normal luxury (highly price elastic).
What is YED influence by?
Any changes in the economy that influence wages/income.
Factors that influence YED?
- a recession that causes wages to fall. (Demand for inferior increases)
- period of economic growth, increase in wages.
- Minimum wage legislation.
- taxation.
- increase in international trade.
What is XED?
Cross price elasticity of demand which is the responsiveness for changes in quantity demanded for X from the change in price of Y.
What is XED talking about?
How changes in prices of compliments and substitutes effect the demand of a related product.
How do you calculate XED?
Original price/ original QD X change in QD/ change in price.
What does a negative sign on the XED show? What does the higher value show?
That the products are compliments. Shows they are strong compliments.
What will the XED be if the goods are complimentary?
Bellow 0.
What does the positive sign on the XED show? What does a higher XED show?
That they are substitutes. It shows that they have a strong relationship (strong substitutes).
What does it mean when the XED is 0? Or if it is closer to 0?
That the goods are unrelated. When XED is closer to 0 it means the relationship between the goods is weaker.
What is the revenue rule of PED trying to achieve?
Maximising profits.
What is the revenue rule of PED?
- that a firms should increase price for inelastic in demand products and decrease the price for elastic in demand products.
Why is knowledge on PEDs important to gov? (Consider inelastic and elastic).
Gov- can raise tax to inelastic demand products without harming firms as they can shift price onto consumers.
Also subsidising right products (elastic to demand) as they will get a greater proportional increase in demand.
Why is knowledge on XED important to firms?
As they seek to maximise profits.
So use knowledge to consider:
- adjusting price as a strategy.
- help predict the likely impact of competitors price changes on their sales.
Why is knowledge on YED important to firms?
Useful when maintaining maximin profit during periods of recession.
Eg.
- firms consider providing more inferior goods during a recession.
- producing more normal goods specifically normal luxury during periods of economic growth.
