2.2 Price elasticity, Income elasticity and cross elasticity of demand

Question 1

What is price elasticity of demand (PED)?
What is the formula for PED?

Answer 1

It is the responsiveness of a change in demand to a change in price
%change in quantity demanded / %change in price

Question 2

What is a price ELASTIC good?
What is the PED value for an elastic good (sign doesn’t matter)

Answer 2

This is when a change in price results to an even bigger change in demand
PED is greater than 1

Question 3

What is a price INELASTIC good?
What is the PED value for an inelastic good (sign doesn’t matter)?

Answer 3

This is when a change in demand is relatively unresponsive to a change in price
PED is less than 1

Question 4

What is a UNITARY elastic good?
What is the PED value of a unitary good (sign doesn’t matter)?

Answer 4

Change in demand is equal to the change in price
PED = 1

Question 5

What is a perfectly INELASTIC good?
What is the PED value of a perfectly inelastic good (sign doesn’t matter)?

Answer 5

This is when the demand does not change due to a change in price
PED = 0

Question 6

What is a perfectly ELASTIC good?
What is the PED of a perfectly elastic good (sign doesn’t matter)?

Answer 6

This is when the demand falls to 0 when price changes
PED = infinity

Question 7

What are the factors influencing PED (pneumonic)

Answer 7

SPLAT
Substitutes - if a good has many substitutes, it is more price elastic
Percentage of income - If it takes up a lot of your income it is price inelastic
Luxury/necessity - A necessary good will be very price inelastic
Addictiveness/habitual consumption - If you are addicted, it will be price inelastic
Time period - A good that lasts a long time has a more elastic demand as consumers wait to buy another one

Question 8

What is income elasticity of demand (YED)?
What is the formula of YED?

Answer 8

It is the responsiveness of a change in demand to a change in income
% change in quantity demanded / % change in income

Question 9

What is an inferior good? What is its YED value?

Answer 9

As income increases, demand falls. The goods can be seen as “inferior”. YED is NEGATIVE

Question 10

What is a normal good? What is its YED value?

Answer 10

As income increases, demand increases. YED is POSITIVE

Question 11

What is a luxury good? What is its YED value?

Answer 11

As income increases, an even bigger in demand increases. YED is bigger than 1

Question 12

What is cross elasticity of demand (XED)?
What is the formula of XED?

Answer 12

It is the responsiveness of a change in demand of one good to a change in price of another good
% change in quantity demanded of X / % change in price of good Y

Question 13

What is a complement good? What is XED value?

Answer 13

If one good becomes more expensive, the quantity demanded for both goods will fall. XED is NEGATIVE

Question 14

What is the difference between close complements and weak compliments?

Answer 14

Close compliments - a small fall in price of good X, leads to a large increase in QD of Y
Weak compliments - a large fall in the price of X, leads to a small increase in QD of Y

Question 15

What is a substitute good?

Answer 15

They can replace another good. The XED value is POSITIVE and the demand curve is upward sloping

Question 16

What is the difference between a close substitute and a weak substitute?

Answer 16

Close substitute - a small increase in the price of good X leads to a large increase in the QD of Y
Weak substitutes - a large increase in the price of a good leads to a smaller increase in QD of Y

Question 17

What is the XED value of unrelated goods?

Answer 17

XED = 0