1.2.3 Price, income, and cross elasticities of demand

Question 1

Price Elasticity of Demand (PED)

Answer 1

Measures the responsiveness of quantity demanded after a change in price

Question 2

Formula: PED

Answer 2

PED= % change in quantity demanded / % change in price

Question 3

Elastic PED

Answer 3

PED > 1

Question 4

Perfectly elastic PED

Answer 4

PED = infinity

Question 5

Inelastic PED

Answer 5

PED < 1

Question 6

Perfectly inelastic PED

Answer 6

PED = 0

Question 7

Unitary elastic PED

Answer 7

PED = 1

Question 8

Income Elasticity of Demand (YED)

Answer 8

Measures the responsiveness of quantity demanded after a change in income

Question 9

Formula: YED

Answer 9

YED = %change in quantity demanded / %change in income

Question 10

Inferior good

Answer 10

YED<0

Question 11

Normal good

Answer 11

YED>0

Question 12

Luxury good

Answer 12

YED>1

Question 13

Cross elasticity of demand (XED)

Answer 13

Measures the responsiveness of a quantity demanded for good A following a change in price for good B.

Question 14

Formula: XED

Answer 14

XED=%change in quantity demanded for good A/%change in price for Good B

Question 15

Substitutes

Answer 15

XED>0

Question 16

Complementary goods

Answer 16

XED<0

Question 17

Unrelated goods

Answer 17

XED=0

Question 18

Factors influencing elasticities

Answer 18

-Availability of substitutes - if there are less substitutes in a market, it makes it harder for consumers to switch, making PED inelastic.

-Habitual behaviour - if a good addictive, consumers are forced by their addiction to purchase it, making PED inelastic.

-Degree of necessity - if prices rise for a necessity good, consumers still need to buy it, making it PED inelastic.

-Time - if prices rise in the short-term it will be harder for a consumer to find cheaper alternatives, making PED inelastic.

-Proportion of consumer’s income allocated to spending on a good - if a good takes up a low proportion of a consumers income, it is less likely to have a significant impact on a consumers ability to buy it, making it PED inelastic.

Question 19

Significance of PED for firms

Answer 19

-If a product has a low PED, the quantity demanded does not change, significantly with the price.
-If, for example, a product with a PED of -0.1 had a 10% price rise, sales volume would fall by 1% (ceteris paribus), so the 10% higher price per unit would far outweigh the 1% reduction in units sold.
-The lower the PED, the easier it is to boost revenue by increasing the price.

Question 20

The relationship between PED and total revenue (including a calculation)