1.2.3 Price, income, cross elasticises of demand

Question 1

Define price elasticity of demand

Answer 1

PED measures the responsiveness of demand to a change in price. % change of QD / % change of P

Question 2

Define income elasticity of demand

Answer 2

YED measures the responsiveness of demand to change in income. % change of QD / % change of Y

Question 3

Define cross elasticity of demand

Answer 3

XED measures the responsiveness of demand of good A to change in the price of good B. % change of QD of good A / % change of price in good B

Question 4

Define a normal good and link it to elasticity of demand

Answer 4

A normal is one where demand increases if price increases. It has a positive YED

Question 5

Define inferior good and link it to elasticity of demand

Answer 5

An inferior good is one where demand decreases if income increases. It has a negative YED

Question 6

Define substitute and link to cross elasticity

Answer 6

A substitute is a good where, if the price increases to the point where demand drops, there is an alternative good that consumers will buy instead, causing the demand of the second good to increase. It has a positive XED

Question 7

Define compliment and link to cross elasticity

Answer 7

A compliment is a good that is purchased or used with another good. It has a negative XED

Question 8

How do you calculate percentage change?

Answer 8

( New - Old / Old ) x 100

Question 9

What range of values are there for PED and what does each value mean?

Answer 9

0-0.9 = Relatively Inelastic
1 = Unitarily Elastic
1 - infinity = Relatively Elastic

Question 10

What is the formula for calculating PED?

Answer 10

% change of QD / % change of P

Question 11

What is the formula for calculating YED?

Answer 11

% change of QD / % change of Y

Question 12

What is the formula for calculating XED?

Answer 12

% change of QD of good A / % change of good B

Question 13

Name 4 factors effecting PED and explain how these factors effect elasticity

Answer 13

Proportion of income spent - This refers to the amount of income spent on a product and the effect it has on their total disposable income i.e one chocolate bar wouldn’t be very elastic as they are usually less than £1 whereas a sofa which is closer to £1000 will be more price elastic because it takes up more of the income.
Availability of substitutes - The more substitutes the more elastic the product will be as consumers could just switch to another product whereas if it had no substitutes then it would be inelastic.
Necessity - If a good is essential then it will be price inelastic (more so if there are less substitutes) however if the good is a luxury it will be price elastic especially if there are substitutes.
Time - The longer the time period is, the more elastic the product is because it takes time for consumers to change their buying habits.

Question 14

If demand is inelastic and price increases, what effect will this have on the firms revenue?

Answer 14

Total revenue will increase because the rise in price is greater than the fall in demand

Question 15

If demand is inelastic and price falls, what will effect will this have on the firms revenue?

Answer 15

Total revenue will decrease because the rise in price is less than the fall in demand

Question 16

|f demand is elastic and price increases, what effect will this have on the firms revenue?

Answer 16

Total revenue will decrease because demand will drop due to the rise in price.

Question 17

If demand is elastic and price decreases, what effect will this have on the firms revenue?

Answer 17

Total revenue will increase because demand will rise due to the drop in price