4.1.3.2 price, income and cross elasticities of demand

Question 1

what is PED?

Answer 1

the price elasticity of demand is the responsiveness of a change in demand to a change in price

Question 2

what is the formula for PED?

Answer 2

% change in quantity demanded / % change in price

Question 3

is the value of price elasticity of demand positive or negative and why?

Answer 3

is negative due to the assumed inverse relationship between price and quantity demanded

Question 4

what does it mean if a good is price elastic?

what is the numerical value?

Answer 4

a price elastic good is very responsive to change in price

the change in price leads to an even bigger change in demand

numerical value for PED is more than 1
the change in price has led to a larger % change in Q demanded

Question 5

what does it mean if a good is price inelastic?
what’s the numerical value?

Answer 5

a price inelastic good has a demand that is relatively unresponsive to a change in a price

PED = less than 1
the change in price has led to a smaller % change in quantity demanded

Question 6

what is the diagram for a relatively elastic good?

Answer 6

Question 7

what is the diagram of the inelastic segment of a demand curve?

Answer 7

Question 8

what is a unitary elastic good?
what’s the numerical value?

Answer 8

a unitary elastic good has a change in demand which is equal to the change in price

PED = 1
the change in price has led to the same % change in Q demanded

Question 9

how do you show unitary elastic demand on a diagram?

Answer 9

Question 10

what is a perfectly inelastic good?
what’s the numerical value?

Answer 10

has a demand which doesn’t change when price changes
PED = 0
the change in price has lead to no change in Q demanded

Question 11

what is perfectly elastic good?
what’s the numerical value?

Answer 11

has a demand which falls to zero when price changes

PED = infinity
the change in price has led to an infinitely large change in Q demanded

Question 12

how do you show a perfectly inelastic good on a diagram?

Answer 12

Question 13

how do you show a perfectly elastic good on a diagram

Answer 13

Question 14

how does necessity affect PED?

Answer 14

a necessary good has a relatively inelastic demand
ie) bread/electricity

• even if the prices increase significantly, consumers will still demand necessary goods because they need it
• luxury goods have a more elastic demand
• if the price of flights increases, demand is likely to fall significantly

Question 15

how does substitues affect PED?

Answer 15

• if a good has several substitutes then demand is more price inelastic
  ie) android phones rather than iphones
• elasticity can change within markets
• market for bread is less elastic than market for white bread
  -> because there’s less subs for bread in general but are serval subs for white bread
  -> so white bread is more price elastic
• the more available the substitutes, the more price elastic the demand
• in the LONG RUN, consumers have time to respond and finds subs
  -> so D becomes more price elastic
• in the SHORT RUN, consumers don’t have time
  -> therefore D is more inelastic

Question 16

how does addictiveness/habitual consumption affect PED?

Answer 16

• D for goods like cigarettes isn’t sensitive to price changes

-> because consumers become addicted
-> so D doesn’t stop even if price increases

Question 17

how does proportion of income spent on the good affect PED?

Answer 17

• if a good only takes up a small proportion
  ie) a magazine which rose from £1.50 to £2
• demand is likely to be relatively price inelastic
• if good takes up significant proportion
  ie) cars which rise from £15,000 to £20,000
• demand is likely to be more price elastic

Question 18

how does durability of the good affect PED?

Answer 18

• good which lasts a long time like a washing machine has more elastic demand because consumers wait to buy another one

Question 19

how does peak and off-peak demand affect PED?

Answer 19

• during peak times the demand is more price in elastic

eg) train tickets from 9am to 5pm

Question 20

elasticity of demand and tax revenue

Answer 20

• indirect tax will fall differently on consumers and firms, depending on if the good has an elastic/in elastic demand
• taxes however shift the supply curve, not demand
• if a firm sells a good with an inelastic demand, they’re likely to put most of the tax burden on the consumer, because they know a price increase won’t cause D to fall significantly
• if a firm sells a good with an elastic demand, they’re likely to take most of the tax burden upon themselves, because they know a price increase means D is likely to fall, which will lower their overall revenue

Question 21

how do you show the effect of indirect tax on an inelastic demand good on a diagram?

and explain it?

Answer 21

an increase in tax will decrease supply from S1 to S2 which increases price from P1 to P2 and therefore demand contracts from Q1 to Q2

Question 22

how do you show the effect of indirect tax on an elastic demand good on a diagram?

and explain it?

Answer 22

demand will fall significantly from Q1 to Q2

Question 23

an elastic demand good or inelastic demand good and their indirect tax approach

which is better for raising government revenue

Answer 23

inelastic demand = most effective for raising gov revenue

elastic demand = not as effective, but if a gov wants to reduce the demand of a particular good, it’s effective

Question 24

what is a subsidy?

Answer 24

is a payment from the gov to firms to encourage the production of a good and to lower their average costs
has the opposite effect of a tax because it increases upply

Question 25

where does the benefit of a subsidy go?

Answer 25

can go to both the producer or the consumer producer - in the form of increase revenue consumer - in the form of lower prices

Question 26

how do you show the effect of a subsidy on elasticity of demand on a diagram?

Answer 26

Question 27

PED and total revenue?

Answer 27

total revenue is equal to average price times quantity sold TR=PxQ - if a good has an in elastic demand, the firm can raise its price and quantity sold will not fall significantly - this will increase total revenue - if a good has an elastic demand and the firm raises its price, quantity sold will fall - this will reduce total revenue

Question 28

what is YED?

Answer 28

income elasticity of demand is the **responsiveness of a change in demand to a change in income**

Question 29

what’s the formula for YED?

Answer 29

YED = % change in Q demanded / % change in real income

Question 30

what is an inferior good? what’s the numerical value?

Answer 30

those which see a fall in demand as income increases eg) the value options at supermarkets could be seen as inferior -> as income increases, consumers switch to branded goods YED = less than 0

Question 31

what is a normal good? what’s the numerical value?

Answer 31

with normal goods, demand increases as income increases YED = more than 0

Question 32

what’s a luxury good? what’s the numerical value?

Answer 32

with luxury goods an increase in income causes an even bigger increase in demand YED = more than 1 eg) a holiday is a luxury good - luxury goods are also normal goods, and they have an elastic income - during periods of prosperity, like economic growth when real incomes are rising. firms might switch to producing more luxury goods and fewer inferior goods because demand for luxury goods will be increasing

Question 33

what is negative income elasticity? what’s the numerical value?

Answer 33

when demand for a product is negative income elastic YED = less than 0 the increase in income has led to a fall in demand negative income elastic goods are referred to as inferior goods

Question 34

what does income elastic demand mean? what’s the numerical value?

Answer 34

demand for a product is income elastic YED = greater than 1 increase in real income leads to greater % in demand income elastic goods are often referred to as luxury goods

Question 35

what does income inelastic demand mean? what’s the numerical value?

Answer 35

- demand for a product is income in elastic YED = between 0 and 1 increase in real income leads to smaller % increase in demand income elastic goods are often referred to as basic goods

Question 36

what is XED?

Answer 36

cross elasticity of demand is the responsiveness of a change in demand of one good, X, to a change in price of another good, Y

Question 37

what’s the formula for XED?

Answer 37

XED = % change in Q demanded of product A / % change in price of product B

Question 38

what value of XED do complementary goods have? what happens with complementary goods?

Answer 38

a negative XED - if one good becomes more expensive the Q demanded for both goods will fall

Question 39

what’s the difference between close and weak complements?

Answer 39

close complements - a small fall in price of good X leads to a large increase in quantity demanded of Y weak complements - a large fall in price of good X leads to only a small increase in Q demanded of Y

Question 40

how do you show close complements on a diagram?

Answer 40

Question 41

how do you show weak complements on a diagram?

Answer 41

Question 42

what value of XED do substitute goods have? what happens with them?

Answer 42

subs can replace another good so the XED is positive - the demand curve is upward sloping - if the price of one brand of TV increases, consumers might switch to another brand

Question 43

what’s the difference between close subs and weak subs?

Answer 43

close subs - a small increase in the price of good X leads to a large increase in QD of Y weak subs - a large increase in the price of good X leads to a smaller increase in QD of Y

Question 44

how do you show close subs on a diagram?

Answer 44

Question 45

how do you show weak subs on a diagram?

Answer 45

Question 46

what value of XED do unrelated goods have?

Answer 46

have an XED equal to 0

Question 47

why are firms interested in XED?

Answer 47

- firms are interested in XED because it allows them to see how many competitors they have - therefore they’re less likely to be affected by price changed by other firms, if they’re selling complementary goods or subs