4.1.3.2 price, income and cross elasticities of demand Flashcards
what is PED?
the price elasticity of demand is the responsiveness of a change in demand to a change in price
what is the formula for PED?
% change in quantity demanded / % change in price
is the value of price elasticity of demand positive or negative and why?
is negative due to the assumed inverse relationship between price and quantity demanded
what does it mean if a good is price elastic?
what is the numerical value?
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
what does it mean if a good is price inelastic?
what’s the numerical value?
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
what is the diagram for a relatively elastic good?
what is the diagram of the inelastic segment of a demand curve?
what is a unitary elastic good?
what’s the numerical value?
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
how do you show unitary elastic demand on a diagram?
what is a perfectly inelastic good?
what’s the numerical value?
has a demand which doesn’t change when price changes
PED = 0
the change in price has lead to no change in Q demanded
what is perfectly elastic good?
what’s the numerical value?
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
how do you show a perfectly inelastic good on a diagram?
how do you show a perfectly elastic good on a diagram
how does necessity affect PED?
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
how does substitues affect PED?
- 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
how does addictiveness/habitual consumption affect PED?
- D for goods like cigarettes isn’t sensitive to price changes
-> because consumers become addicted
-> so D doesn’t stop even if price increases
how does proportion of income spent on the good affect PED?
- 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
how does durability of the good affect PED?
- good which lasts a long time like a washing machine has more elastic demand because consumers wait to buy another one
how does peak and off-peak demand affect PED?
- during peak times the demand is more price in elastic
eg) train tickets from 9am to 5pm
elasticity of demand and tax revenue
- 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
how do you show the effect of indirect tax on an inelastic demand good on a diagram?
and explain it?
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
how do you show the effect of indirect tax on an elastic demand good on a diagram?
and explain it?
demand will fall significantly from Q1 to Q2
an elastic demand good or inelastic demand good and their indirect tax approach
which is better for raising government revenue
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
what is a subsidy?
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
where does the benefit of a subsidy go?
can go to both the producer or the consumer
producer
- in the form of increase revenue
consumer
- in the form of lower prices
how do you show the effect of a subsidy on elasticity of demand on a diagram?
PED and total revenue?
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
what is YED?
income elasticity of demand is the responsiveness of a change in demand to a change in income
what’s the formula for YED?
YED = % change in Q demanded / % change in real income
what is an inferior good?
what’s the numerical value?
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
what is a normal good?
what’s the numerical value?
with normal goods, demand increases as income increases
YED = more than 0
what’s a luxury good?
what’s the numerical value?
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
what is negative income elasticity?
what’s the numerical value?
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
what does income elastic demand mean?
what’s the numerical value?
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
what does income inelastic demand mean?
what’s the numerical value?
- 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
what is XED?
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
what’s the formula for XED?
XED = % change in Q demanded of product A / % change in price of product B
what value of XED do complementary goods have?
what happens with complementary goods?
a negative XED
- if one good becomes more expensive the Q demanded for both goods will fall
what’s the difference between close and weak complements?
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
how do you show close complements on a diagram?
how do you show weak complements on a diagram?
what value of XED do substitute goods have?
what happens with them?
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
what’s the difference between close subs and weak subs?
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
how do you show close subs on a diagram?
how do you show weak subs on a diagram?
what value of XED do unrelated goods have?
have an XED equal to 0
why are firms interested in XED?
- 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
