3.3 Price & Income Elasticity of Demand​

Question 1

What is Elasticity?​

Answer 1

Elasticity measures the responsiveness of demand to a change in a relevant variable – such as price or income​

Question 2

Definition: Price Elasticity of Demand​

Answer 2

Price elasticity of demand measures the extent to which the quantity of a product demanded is affected by a change in price​

Question 3

Calculating Price Elasticity of Demand - Formula

Answer 3

% Change in Quantity Demanded​
/
% Change in Price​

Question 4

Price elastic features

Answer 4

value of PED More than 1
Change in demand is more than the change in price​

Question 5

Price inelastic​ features yo

Answer 5

value of PED Less than 1
​Change in demand is less than the change in price
a chnage in price doesnt really effect demand

Question 6

Unitary price elasticity

Answer 6

value of PED is Exactly = 1
Change in demand = change in price

Question 7

Why does Price Elasticity of Demand Matters

Answer 7

If PED > 1 (price elastic) 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​

Opposite is the case if PED < 1 (price inelastic)

Question 8

Factors Influencing PED

Answer 8

Brand strength​
Products with strong brand loyalty and reputation tend to be price inelastic​

Necessity​
The more necessary a product, the more demand tends to be inelastic​

Habit​
Products that are demanded and consumed as a matter of habit tend to be price inelastic​

Availability of substitutes​
Demand for products that have lots of alternatives (substitutes) tends to be price elastic​

Time​
In the short-run, price changes tend to have less impact on demand than over longer periods​

Question 9

Definition: Income Elasticity of Demand

Answer 9

Income elasticity of demand measures the extent to which the quantity of a product demanded is affected by a change in income​

Question 10

Calculating Income Elasticity of Demand - Formula​

Answer 10

% Change in Quantity Demanded​
/
% Change in Income​

Question 11

Interpreting Income Elasticity of Demand

Answer 11

Most most normal products​
A rise in consumer income will result in a rise in demand​
A fall in consumer income will result in a fall in demand​

Extent of the change (elasticity)​
This will vary depending on the type of product (e.g. luxury v necessity)

Question 12

Income Elasticity: Luxuries

Answer 12

Luxuries​

Income elasticity more than 1​

As income grows, proportionally more is spent on luxuries​

Examples:​

Expensive holidays​

Branded goods​

Question 13

Income Elasticity: Necessities

Answer 13

Necessities​

Income elasticity less than 1, but more than 0​

As income grows, proportionally less is spent on necessities​
Necessities are always bought, at the same quanitiy(mainly) so when incomes increases they dont need to buy more

Examples:​

Staple groceries (e.g. milk)​

Own-label goods​

Question 14

Inferior Goods (income elasticity less than 1) features

Answer 14

For inferior goods, as income rises demand actually falls​

Why does demand fall?​

Consumers switch to better alternatives​

Substitute products become affordable

Question 15

Limitations of Calculating & Using Elasticities

Answer 15

Can be difficult to get reliable data​

Other factors affect demand (e.g. consumer tastes)​

Many markets subject to rapid technological change – make previous data less reliable​

Competitors will react – pricing decisions can’t be taken in isolation!

Question 16

PED AND IED overview - feature points

Answer 16

Elasticities provide useful insights for management in decision-making​

Firms tend to like to have products with inelastic demand​

Building strong brands and product USPs is a good strategy for making demand more price inelastic