2.5: Price and income Elasticity Of Demand

Question 1

Elasticity of demand

Answer 1

Responsiveness of quantity demanded for a good due to a change in factor that affects demand

Question 2

Demain is price/income elasticity if…

Answer 2

A small change in price or income leads to a large change in demand

Question 3

Price elastic demand

Answer 3

• relatively small change in prices causes a larger percentage change in the quantity demanded
• customers are highly sensitive to price changes
• more incentive to switch to substitutes

Question 4

Price inelastic demand

Answer 4

Small change in price causes a smaller proportionate change in quantity demanded

Question 5

Price elasticity of demand (PED)

Answer 5

• measures degree of responsiveness of quantity demanded following a change in the price of a product
• percentage change in quantity demanded /divided/ percentage change in price

Question 6

Percentage change formula

Answer 6

(New figure - old figure) x 100

Divided by old figure

Question 7

PED > 1

Answer 7

Demand is price elastic

Question 8

PED <1

Answer 8

Demand is price inelastic

Question 9

Degrees of PED

Answer 9

1) PED = 0 (perfectly inelastic)
2) PED = infinite (perfectly elastic)
3) PED = 1 (unitary price elastic demand)

Question 10

Perfectly inelastic

Answer 10

• demand curve is vertical
• change in price has no impact on quantity demanded
• theoretical extreme
• the product has no substitutes

Question 11

Perfectly price elastic

Answer 11

• demand curve is horizontal
• demand exists at one price only
• theoretical extreme
• customers switch to substitutes that are perfect and accessible

Question 12

Unitary elasticity of demand

Answer 12

• curve is directly proportional
• given price change leads to the same percentage change in quantity demanded
• changing price leads to no change in revenue

Question 13

PED along a regular demand curve

Answer 13

• value of PED increases as price rises as demand is pore responsive when price accounts for a larger potion of income
• at the midpoint PED = 1
• above the midpoint the PED = >1
• below the midpoint PED = <1

Question 14

Determinants of PED

Answer 14

• acronym = TINS
• T time period
• I income portion spent
• N degree of necessity
• S number and closeness of substitutes

Question 15

Time period as a PED determinant

Answer 15

• over time a good becomes more elastic
• consumers have time to find substitues, firms have time to develop substitutes
• increased durability = decreased elasticity (they last, you dont need to buy a new one)

Question 16

Portion of income as a determinant of demand

Answer 16

• Ceteris paribus, the greater the proportion os the consumers real income spent on a product, the more price elastic it will be

Question 17

Degree of Necessity and PED

Answer 17

• essential products tend to be more inelastic
• luxury goods are more elastic
• degree of necessity can be subjective ( trends, staples and preferences, addiction)

Question 18

Substitutes and PED

Answer 18

• the greater the number and availability of close substitutes, the higher the PED value
• some companies use trademarks and non-compete clauses to restrict number of substitutes + innovation

Question 19

Relationship between PED and total revenue

Answer 19

• Value of PED shows how a firms revenue will change if they change the price of a product
• elastic demand = increased revenue by decreasing price
• inelastic demand = increased revenue by increasing price

Question 20

Elasticity of demand and decision makers

Answer 20

• PED informs decision makers on effect of price changes on sales revenue
• firms can employ price discrimination or dynamic/ surge pricing to capitalize off of fluctuating elasticity
• government used PED to determine taxation policies

Question 21

Sales revenue formula

Answer 21

Price x quantity traded

Question 22

PED and taxation

Answer 22

• heavy taxes on demerit good that are often inelastic (alcohol, gambling, cigs)
• dissuade use + high tax revenue

Question 23

Primary goods and PED

Answer 23

• raw materials
• inelastic
• lack close substitutes
• necessity is high
• small proportion of income vs labour and capital

Question 24

Manufactured goods PED

Answer 24

• relatively elastic
• degree of necessity is lower
• large proportion of income
• more durable, dont need frequent replacement

Question 25

Income elasticity of demand

Answer 25

Measures the degree of responsiveness of demand following a change in income

Question 26

YED formula

Answer 26

Percentage change in quantity demanded /divided by/ percentage change in income

Question 27

Income elastic demand

Answer 27

• responsive to income change
• YED > 1
• percentage change in quantity demanded is greater than percentage change in income
• luxury goods and services

Question 28

Income inelastic demand

Answer 28

• demand not responsive to income change
• percentage change in quantity demanded is greater than percentage change in income
• necessities + staple goods

Question 29

YED negative value

Answer 29

• inferior good

- demand increases when income decreases

Question 30

YED positive value

Answer 30

• normal goods
• necessities and luxuries
• demand increases as income increases

Question 31

YED and sectoral change in economy

Answer 31

• primary sector not impacted by income fluctuations

- as country income increases, economy will move towards manufactured sector