1.2.3 Price, income and cross elasticities of demand Flashcards
How to work out PED?
% change in price
How to calculate change?
new value - old value
—————————– x 100
old value
What does the PED value of 0 mean?
Perfectly inelastic. The QD is completely unresponsive to the change in price. Very theoretical.
What does the PED value of 0-1 mean?
Relatively inelastic. The percentage change in QD is less proportional to the percentage change in price. For example addictive products.
What does the PED value of 1 mean?
Unitary elasticity. The percentage change in QD is the same as that of the price.
What does the PED value of 1-∞ mean?
Relatively elastic. The percentage change in QD is more than proportional to the percentage change in price. For example most products.
What does the PED value of ∞ mean?
Perfectly elastic. The percentage change in QD will fall to zero with any percentage change in price. Highly theoretical elasticity.
Factors the influence the PED?
/Availability of substitutes
/Addictiveness of the product
/Price of product as a proportion of income
/Time period
What is YED?
Income elasticity of demand (YED) reveals how responsive the change in quantity demanded is to a change in income.
How to calculate YED?
Percentage change in income
What does the YED value of 0-1 mean?
Normal necessity. Demand increases when income increases. Income elastic. For example commonly purchased items such as food.
What does the YED value of >1 mean?
Normal luxury. Demand increase when income increase. Income elastic. Higher than that of normal necessity. For example a Rolex.
What does the YED value of <0 mean?
Inferior good. Demand decrease when income increase. For example low value beans as people will want Heinz.
Factors that effect YED?
/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
What is XED?
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.
How do you calculate XED?
% change in price of good B
What does the XED value of <0 mean?
Complimentary goods. The negative value indicates that the two goods are complements. The higher the value the stronger the relationship.
What does the XED value of >0 mean?
Substitutes. The positive value indicates that the two goods are substitutes. The higher the value the stronger the relationship.
What does the XED value of 0 mean?
Unrelated goods. A value of zero indicates that there is no relationship between the goods. Closer to zero the weaker the relationship.
Why is knowledge of PED important to firms?
/If their product is price inelastic in demand, they should raise their prices.
/If price elastic in demand, then they should lower their prices.
Why is the knowledge of PED important to governments?
/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
Why is the knowledge of XED important to firms?
/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
Why is the knowledge of YED important to firms?
/Firms should consider providing more inferior goods in a recessionary environment
/Firms should consider providing more luxury products during periods of economic growth
What is the total revenue rule?
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.
