1.2.3 Price, income and cross elasticities of demand

Question 2

How to work out PED?

Answer 2

% change in price

Question 3

How to calculate change?

Answer 3

new value - old value
—————————– x 100
old value

Question 4

What does the PED value of 0 mean?

Answer 4

Perfectly inelastic. The QD is completely unresponsive to the change in price. Very theoretical.

Question 5

What does the PED value of 0-1 mean?

Answer 5

Relatively inelastic. The percentage change in QD is less proportional to the percentage change in price. For example addictive products.

Question 6

What does the PED value of 1 mean?

Answer 6

Unitary elasticity. The percentage change in QD is the same as that of the price.

Question 7

What does the PED value of 1-∞ mean?

Answer 7

Relatively elastic. The percentage change in QD is more than proportional to the percentage change in price. For example most products.

Question 8

What does the PED value of ∞ mean?

Answer 8

Perfectly elastic. The percentage change in QD will fall to zero with any percentage change in price. Highly theoretical elasticity.

Question 9

Factors the influence the PED?

Answer 9

/Availability of substitutes
/Addictiveness of the product
/Price of product as a proportion of income
/Time period

Question 10

What is YED?

Answer 10

Income elasticity of demand (YED) reveals how responsive the change in quantity demanded is to a change in income.

Question 11

How to calculate YED?

Answer 11

Percentage change in income

Question 12

What does the YED value of 0-1 mean?

Answer 12

Normal necessity. Demand increases when income increases. Income elastic. For example commonly purchased items such as food.

Question 13

What does the YED value of >1 mean?

Answer 13

Normal luxury. Demand increase when income increase. Income elastic. Higher than that of normal necessity. For example a Rolex.

Question 14

What does the YED value of <0 mean?

Answer 14

Inferior good. Demand decrease when income increase. For example low value beans as people will want Heinz.

Question 15

Factors that effect YED?

Answer 15

/During a recession wages usually fall and demand for inferior goods rises and luxury goods falls
/During a period of economic growth and rising wages, demand for luxury goods increases and demand for inferior goods decreases
/Other influences on income include minimum wage legislation, taxation, increased international trade

Question 16

What is XED?

Answer 16

Cross price elasticity of demand (XED) reveals how responsive the change in quantity demanded for good A is to a change in price of good B. Such as complimentary and substitutes.

Question 17

How do you calculate XED?

Answer 17

% change in price of good B

Question 18

What does the XED value of <0 mean?

Answer 18

Complimentary goods. The negative value indicates that the two goods are complements. The higher the value the stronger the relationship.

Question 19

What does the XED value of >0 mean?

Answer 19

Substitutes. The positive value indicates that the two goods are substitutes. The higher the value the stronger the relationship.

Question 20

What does the XED value of 0 mean?

Answer 20

Unrelated goods. A value of zero indicates that there is no relationship between the goods. Closer to zero the weaker the relationship.

Question 21

Why is knowledge of PED important to firms?

Answer 21

/If their product is price inelastic in demand, they should raise their prices.
/If price elastic in demand, then they should lower their prices.

Question 22

Why is the knowledge of PED important to governments?

Answer 22

/If they tax price inelastic in demand products, they can raise tax revenue without harming firms too much
/Consumers are less responsive to price changes so firms will pass on the tax to the consumer
/If they subsidies price elastic in demand products, there can be a greater than proportional increase in demand

Question 23

Why is the knowledge of XED important to firms?

Answer 23

/It can help them to adjust pricing strategies for substitute and complementary goods
/It can help them understand the likely impact of competitors’ pricing strategies on their sales

Question 24

Why is the knowledge of YED important to firms?

Answer 24

/Firms should consider providing more inferior goods in a recessionary environment
/Firms should consider providing more luxury products during periods of economic growth

Question 25

What is the total revenue rule?

Answer 25

The total revenue rule states that in order to maximise revenue, firms should increase the price of products that are inelastic in demand and decrease prices on products that are elastic in demand.