1.2.3 Price, Income, Cross Elasticity of Demand

Question 1

What is Price Elasticity of Demand (PED)?

Answer 1

A measure of the sensitivity of quantity demanded to a change in price

Question 2

How do you measure PED?

Answer 2

%change in demand / %change in price

Question 3

What is an elastic PED?

Answer 3

When a good has a PED of greater than 1

Question 4

What is an inelastic PED?

Answer 4

A good that has a PED of less than 1

Question 5

Why is the PED always negative?

Answer 5

Because the demand curve is a negative correlation

Question 6

What does unitary elastic mean?

Answer 6

A good with a PED of exactly 1

Question 7

Is an elastic PED good have a steep curve or shallow curve?

Answer 7

Shallow

Question 8

What 4 factors affect PED?

Answer 8

• luxury or necessity
• availability of substitutes
• time to look for alternatives
• % of income

Question 9

If a good is a luxury is it PED elastic or inelastic and why?

Answer 9

A luxury good is PED elastic because a consumer does not need the good so is quickly deterred by an increase in price

Question 10

If a good is a necessity, is it PED elastic or inelastic and why?

Answer 10

It is PED inelastic because the consumer needs the good for essential reasons and is willing to pay the higher price

Question 11

If a good has loads of available substitutes, is it PED elastic or inelastic and why?

Answer 11

It is PED elastic because consumers are able to buy cheaper, suitable alternatives if the price of the original good rises

Question 12

If a good is a small percentage of your income, is it PED elastic or inelastic and why?

Answer 12

It is PED inelastic because a rise in price for a good that is priced low will often go unnoticed by the consumer

Question 15

If you don’t have a lot of time to consider your purchase, the three good going to be PED elastic or inelastic and why?

Answer 15

PED inelastic because you don’t have time to search for alternatives to buy instead

Question 16

What do PEDs estimate?

Answer 16

The likely impact on total revenue following a change to price

Question 17

If the good is elastic, what do you have to do to your good to increase revenue?

Answer 17

Cut prices

Question 18

Why do you have to cut prices of an elastic good to increase revenue?

Answer 18

Because the customers gained from slashing prices are more than those who were willing to pay through higher price

-refer to diagram in answer-

Question 19

If the good is inelastic, what do you have to do to the price to increase revenue?

Answer 19

Increase prices

Question 20

Why do you have to increase the price of an inelastic good to increase the revenue

Answer 20

Because you only lose a small amount of customers compared to your vast amount of more revenue you get from customers willing to pay more

Question 21

What is income elasticity of demand (YED)?

Answer 21

A measure of the sensitivity of demand following a change in comsumer income

Question 22

How to you calculate YED?

Answer 22

%change in demand / %change in income

Question 23

What YED does a normal good have?

Answer 23

Positive YED

Question 24

What YED does an inferior good have?

Answer 24

Negative YED

Question 25

Good A has a YED of +1.5, explain the good…

Answer 25

Good A is a normal good, it is income elastic. When income rises by 1%, it leads to a 1.5% increase in quantity demanded

Question 26

Good C has a YED of of -0.5, explain the good…

Answer 26

Good C is an inferior good, it is income inelastic. When income rises by 1% demand falls by 0.5%

Question 27

What are the disadvantages of using a PED?

Answer 27

• no reference to cost so you cannot predict profit
• demand is affected by other factors

Question 28

What is the revelence of YED estimates?

Answer 28

Tells firms the likely changes in revenue when income changes

Question 29

What is Cross Elasticty of Demand (XED)?

Answer 29

A measure of the sensitivity of demand following a change in price of another good or service

Question 30

How do you calculate XED?

Answer 30

%change in demand for good X / %change in price for good Y

Question 31

What does a positive XED show?

Answer 31

Substitute goods

Question 32

What does a negative XED show us?

Answer 32

Complement goods