1.2.5 : Price + Income Elasticity Of Demand

Question 1

What is elasticity ?

Answer 1

Measures the responsiveness of demand to a change in a relevant variable - such as price or income

Question 2

What is price elasticity of demand ?

Answer 2

Measures the extent to which the quantity of a product demanded is affected by a change in price

Question 3

What is the PED equation ?

Answer 3

% change in quantity demanded / % change in price

Question 4

What are the different types of elasticity ?

Answer 4

Price elastic - value of PED = more than 1 - change in demand is more than the change in price
Price inelastic - value of PED = less than 1 - change in demand is less than the change in price
Unitary price elasticity - value of PED = exactly 1 - change in demand = change in price

Question 5

What happens when the PED > 1 ?

Answer 5

Then a change in price will cause a larger change in demand :
Overall revenues would increase with a price cut
Overall revenues would fall with a price increase

Question 6

What are the factors affecting PED ?

Answer 6

Brand strength - products with strong brand loyalty and reputation tend to be more elastic
Necessity - the more necessary a product , the more the demand tends to be elastic
Habit - products that are demanded and consumed as a matter of habit tend to be price elastic
Availability of substitutes - demand for products that have a lot of substitutes tend to be more elastic
Time - in the short-run, price changes end to have less impact on demand than over longer periods

Question 7

What is income elasticity of demand ?

Answer 7

Measures the extent to which the quantity demanded is faceted by a change in income

Question 8

What is the impact on luxuries from elasticity of demand ?

Answer 8

Income elasticity more than 1 - as income grows proportionally more is spent on luxuries

Question 9

What is the impact on necessities from the elasticity of demand ?

Answer 9

Income elasticity less than 1 but more than 0 - s income grows proportionally less is spent on necessities

Question 10

What is the differences with inferior goods ?

Answer 10

For inferior goods, s income rises demand actually decreases. It decreases because consumers find better alternatives that are more affordable

Question 11

What are the limitations of calculating and using elasticities ?

Answer 11

Can be difficult to find reliable data.
Other factors affect demand such as consumers tastes
Many markets are subject to technological change
Competitors will react