1.2.3 Price, income and cross elasticities of demand

Question 1

Price Elasticity of Demand (PED)

Answer 1

The sensitivity of demand to changes in price

Question 2

Price elastic demand

Answer 2

Demand is more sensitive to changes in price

Question 3

Price inelastic demand

Answer 3

Demand is less sensitive to changes in price

Question 4

PED calculation

Answer 4

Question 5

% change calculation

Answer 5

Question 6

Elastic demand

Answer 6

If PED (ignoring any minus signs) is greater than 1, demand for the good is elastic.

This means a percentage change in price will cause a larger percentage change in quantity demanded.
The higher the value of PED, the more elastic demand is for the good.

Question 7

Perfectly price elastic demand

Answer 7

Perfectly elastic demand has a PED of infinity and any increase in price means that demand will fall to zero. Consumers are willing to buy all they can obtain at price level, but none at a higher price.

Question 8

Graph showing perfectly price elastic demand

Answer 8

Question 9

Inelastic demand

Answer 9

If PED (ignoring any minus signs) is between 0 and 1, demand for the good is inelastic. This means a percentage change in price will cause a smaller percentage change in quantity demanded.

The smaller the value of PED, the more inelastic demand is for the good.

Question 10

Perfectly price inelastic demand

Answer 10

Perfectly inelastic demand has a PED of 0 and any change in price will have no effect on the quantity demanded. At any price, the quantity demanded will be the same.

Question 11

Graph showing perfectly price inelastic demand

Answer 11

Question 12

Unit elasticity of demand

Answer 12

A good has unit elasticity (PED = +/- 1) if the size of the percentage change in price is equal to the size of the percentage change in quantity demanded.

For example, a 20% decrease in price will lead to a 20% increase in quantity demanded:

Question 13

Key PED values

Answer 13

Price elastic: PED > 1
Unit price elastic: PED = 1
Price inelastic: PED < 1
Perfectly price elastic: ∞
Perfectly price inelastic: 0

Question 14

Income Elasticity of Demand (YED)

Answer 14

The sensitivity of demand to changes in income.

Question 15

What is an inferior good?

Answer 15

A good which demand decreases when income increases.

• Negative YED.

Question 16

What is an normal good?

Answer 16

A good which demand increases when income increases.

• Positive YED.

Question 17

Examples of normal goods

Answer 17

• Ordinary broadband
• Ford focus
• Holiday to Spain
• Streaming subscriptions

^ When income rises, demand for these goods increase.

Question 18

Examples of inferior goods

Answer 18

• ‘Supermarket own brand’ goods.
• Tinned meat/spam, corned beef.
• Instant coffee.
• Bus travel.
• Butlin family holidays in Skegness.

^ When income rises, demand for these goods decrease as people buy alternatives.

Question 19

What are the two types of normal goods?

Answer 19

• Necessity
• Luxury

Question 20

Necessity good

Answer 20

A good which demand increases less than proportionately as income increases.

Example: Food, water, housing, electricity, etc.

Question 21

Luxury good

Answer 21

A good which demand increases more than proportionately as income increases.

Example: Netflix TV, Organic luxury coffee, superfast broadband.

Question 22

YED calculation

Answer 22

Question 23

Veblen goods

Answer 23

Where demand rises as price rises. An increase in price encourages people to buy more of it. This is because they think more expensive goods are better.
- Demand rises as price rises

Question 24

Examples of veblen goods

Answer 24

• Designer clothes
• Modern art
• Vintage wine

Question 25

Demerit goods

Answer 25

Goods with negative externalities.
E.g. Smoking, drugs

Question 26

Merit goods

Answer 26

Goods with positive externalities.
E.g. Education, health care

Question 27

Cross Price Elasticity of Demand (XED)

Answer 27

The sensitivity of demand of one good to changes in the price of another good.

Question 28

Substitutes (XED)

Answer 28

Alternative products.

They have positive XEDs. A fall in the price of one substitute (e.g. rice) will reduce the demand for another (e.g. pasta), The closer the substitute, the higher the positive XED.

Question 29

What are goods if they have an XED of 0?

Answer 29

Independent - Unreleated goods don’t directly affect the demadn of each other - for example, bananas and iPhones.

Question 30

Complements (XED)

Answer 30

Products which are components of a product.

They have negative XEDs. An increase in the price of a good will lead to a reduction in demand for its complements.

Question 31

Calculation for XED

Answer 31

Question 32

Determinants of elasticity

[Think SPLAT!]

Answer 32

Substitutes – If there are lots of alternative products, the product would likely be elastic.
Proportion of income – If a product costs a higher proportion of income, it would be elastic.
Luxury – If goods are a necessity, they will be more inelastic.
Addictiveness – If goods are addictive, they are more likely to be inelastic as people rely on it.
Time period - Over a long period of time, goods will become more elastic.

Question 33

Demand for purchases that cannot be postponed (e.g. emergency plumbing services) tend to be…

Answer 33

Price inelastic.

Question 34

Demand for products with several different uses (e.g. water) tends to be…

Answer 34

Price inelastic.