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economics: theme 1 > 1.2.3 - price, income and cross elasticities of demand > Flashcards

1.2.3 - price, income and cross elasticities of demand Flashcards

1
Q

What does price elasticity of demand (PED) measure?

A

It measures the responsiveness of the quantity demand of a good or service to a change in its price.

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2
Q

What does PED help us understand in simpler terms?

A

It helps us understand how sensitive consumer demand is to changes in price.

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3
Q

What is the formula for calculating PED?

A

PED = (%∆QD)/(%∆P), where %∆ = (difference/original) * 100.

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4
Q

Why is PED always negative?

A

PED is negative because quantity demanded is inversely related to price.

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5
Q

What is the range of values for PED?

A

The values of PED range from 0 to -∞, with a mid-value of -1.

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6
Q

What is the effect of a large number of close substitutes on PED?

A

A large number of close substitutes increases the price elasticity of demand.

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7
Q

How does the cost of switching between products affect PED?

A

Higher switching costs tend to reduce the elasticity of demand.

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8
Q

What is the impact of necessity or luxury on PED?

A

Necessities have inelastic demand, while luxury goods tend to have more elastic demand.

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9
Q

How does the proportion of income allocated to a good affect its PED?

A

Goods that take up a large proportion of income tend to have more elastic demand.

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10
Q

How does the time period allowed for consumers to respond affect PED?

A

The longer the time period, the more elastic the demand.

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11
Q

What effect does habitual consumption have on PED?

A

Habitual consumption tends to make demand more inelastic.

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12
Q

How does brand loyalty affect PED?

A

Brand loyalty makes demand more inelastic.

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13
Q

What is the effect of peak and off-peak demand on PED?

A

Demand tends to be more elastic during off-peak times and more inelastic during peak times.

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14
Q

How does the breadth of definition of a good or service affect its PED?

A

A broadly defined good or service tends to have more inelastic demand.

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15
Q

How does the method of payment (cash vs. digital) affect PED?

A

Different payment methods can affect consumer perception of cost and influence demand elasticity.

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16
Q

What is elastic demand?

A

Elastic demand is when quantity demanded is very responsive to price changes.

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17
Q

What is the PED value for elastic demand?

A

The % change in QD is greater than the % change in P; the value is between -1 and -∞.

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18
Q

What is perfectly elastic demand?

A

PED = -∞, meaning a small price change will lead to an infinite change in quantity demanded as a change in supply will not lead to any change in equilibrium market price (highly competitive markets where supplier has no pricing power, charge same to buyers)

A change in price causes quantity demanded to fall to zero, a change can in demand can be met without any changes in price

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19
Q

What is inelastic demand?

A

Inelastic demand is when quantity demanded is not very responsive to price changes.

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20
Q

What is the PED value for inelastic demand?

A

The % change in QD is less than the % change in P; the value is between 0 and -1.

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21
Q

Why do necessities like food and medicine have inelastic demand?

A

Because consumers are less likely to change their purchasing behavior even if prices change significantly.

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22
Q

What is perfectly inelastic demand?

A

PED = 0, meaning consumers are willing to pay any price for the product, a change in price has no affect on output so demand is completely unresponsive to price

23
Q

What does unitary or unit demand signify?

A

Unitary demand occurs when PED = -1, meaning the % change in QD is the same as the % change in P.

24
Q

Why does PED change along a demand curve?

A

PED changes along a demand curve because it is calculated using proportionate changes, not absolute changes.

25
Q

What happens to PED at the top half of a demand curve?

A

The % change in QD is greater than the % change in P, showing elastic figures at high prices.

26
Q

What happens to PED at the bottom half of a demand curve?

A

The % change in QD is less than the % change in P, showing inelastic figures at low prices.

27
Q

Where is PED = -1 on the demand curve?

A

PED = -1 at the midpoint of the demand curve.

28
Q

How does PED impact total revenue (TR) when demand is elastic?

A

A rise in P leads to a more than proportionate fall in QD, so TR falls. A fall in P leads to a more than proportionate rise in QD, so TR rises.

29
Q

How does PED impact total revenue (TR) when demand is inelastic?

A

A rise in P leads to a less than proportionate fall in QD, so TR rises. A fall in P leads to a less than proportionate rise in QD, so TR falls.

30
Q

What are the factors which make PED change overtime?

A
  • Changes in addictivity (alcohol): as people become more addicted, demand becomes less sensitive to price changes.
  • Availability of substitutes: if more substitutes are available, demand becomes more responsive to price changes.
  • Accessibility/feasibility of complements: easier access to complementary goods can increase demand, making it more sensitive to price changes.
  • Cost of switching (tied to contracts): higher switching costs make demand less responsive to price changes because people are locked in.
  • Lack of rationality: when people make irrational decisions, demand may not respond logically to price changes.
31
Q

What does income elasticity of demand measure?

A

The responsiveness of quantity demanded to a change in income

32
Q

What is the formula for income elasticity of demand?

A

YED = (%∆QD)/(%∆Y), where %∆ = (difference/original) * 100.

33
Q

What are inferior goods?

A

When quantity demanded decreases as incomes rises (e.g. own-brand products, boxed and canned food, low quality clothing)

34
Q

What is the YED value of inferior goods?

A

YED between -∞ and 0, all inferior goods have negative YED

35
Q

What is the YED for inferior goods when demand is income elastic?

A

YED between -∞ and -1

36
Q

What is YED for inferior goods when demand is income inelastic?

A

YED between -1 and 0,

37
Q

What happens to YED during a recession?

A

Demand for inferior goods increases

38
Q

What is the YED value for normal goods?

A

YED between 0 and +∞, all normal goods have positive YED

39
Q

What are normal goods?

A

When quantity demanded increases as incomes rise

40
Q

What is a necessity?

A

When quantity demanded is not very responsive to changes in income, as the quantity needed is the same regardless of income

41
Q

What is the YED value for normal goods?

A

YED between 0 and +1, demand is income inelastic

42
Q

What is a luxury good?

A

When quantity demanded responds greatly to income changes as people are likely to want more as their incomes rise and easily avoid purchasing if incomes decrease

43
Q

What is the YED value for a luxury good?

A

YED between +1 and +∞, demand is income elastic

44
Q

When is demand for goods perfectly income inelastic?

A

When YED = 0

45
Q

What does cross elasticity of demand measure?

A

The responsiveness of quantity demanded of good x to a change in price of good y, where the integer represents the strength of the relationship

46
Q

What is the formula for cross elasticity of demand?

A

XED = (%∆QD of good x)/(%∆P of good y), where %∆ = (difference/original) * 100.

47
Q

What are complementary goods?

A

Goods which go hand-in-hand

48
Q

What is the XED value for complementary goods?

A

XED is negative and between -∞ and 0, as an increase in price leads to a decrease in price for its complement

49
Q

What do different XED values represent for complementary goods?

A
  • Higher the coefficient of XED (ignoring the negative sign), the closer/stronger complements as consumers are likely to change consumption of a good due to change in price of another good
  • Strong complementary goods have XED between -∞ and -1, demand between goods is price elastic
  • Weak complementary goods have XED between -1 and 0, demand between goods is price inelastic
50
Q

What are substitute goods?

A

Goods which are in direct competition with each other

51
Q

What is the XED value for substitute goods?

A

XED is positive and between 0 and +∞, as an increase in price leads to increase in demand for substitute

52
Q

What do different XED values represent for substitute goods?

A
  • Higher the coefficient of XED, closer/stronger substitutes as consumers are more likely to switch to a substitute when there is a change in price
  • Strong substitute goods have XED between +1 and +∞, price between goods is price elastic
  • Weak substitute goods have XED between 0 and +1, price between goods is price inelastic
53
Q

What is the XED value for goods which are unrelated?

A

XED = 0, demand between goods is perfectly price inelastic

economics: theme 1 (7 decks)

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