4.1.3.2 Price, income and cross elasticities of demand Flashcards
Elasticity
A measure of how much one variable changes in response to a change in another variable.
Price elasticity of demand
A measure of the responsiveness of a change in demand for a good or service to a change in its own price.
PED equation
% change in quantity demanded / % change in price
Why is PED always negative?
Price and demand have an inverse relationship.
What are the types of PED?
perfectly elastic = PED= infinity elastic = PED >1 Unitary = PED=1 inelastic = PED<1 perfectly inelastic= PED=0
What does a perfectly elastic demand curve look like?
A perfectly elastic demand curve shows that the demand is infinite at a specific price. Thus, a change in price would eliminate all demand for the product.
What does a relatively elastic demand curve look like?
quantity demanded changes by a larger percentage than price, so demand is relatively responsive to price.
Demand will decrease by a larger percentage than price increased and vice versa
What does a unitary elastic demand curve look like?
With a demand curve of unitary price elasticity, a change in price is met with an equal change in demand
This means that total spending by consumers on the product will remain the same at each price level
What does a relatively inelastic demand curve look like?
Quantity demanded changes by a smaller percentage than price, so demand is relatively unresponsive to price.
Could be because they are less substitutes, could be necessities
What does a perfectly inelastic demand curve look like?
With a perfectly inelastic demand, there is no change in the demand for a product with a change in its price. This means that the demand remains constant for any value of price.
what are factors affecting PED?
Substitutes, Percentage of income, Luxury/necessities, Addictive/habit, Time period
If value of PED is between -1 and 0
price inelastic, given change in price, change in demand is smaller
If value of PED is = -1
unit elastic, % change in price = % change in QD
If value of PED is less than -1
price elastic, given change in price, there is a larger change to quantity demanded
PED along a demand curve
gets more elastic as price rises
gets more inelastic as price falls
Factors influencing ped- 1. Substitutes
High availability = price elastic, an increase in price would cause many consumers to substitute the more expensive good for a cheaper good. More substitutes = more cheaper or expensive prices so more switching so more change to QD
Factors influencing ped- 2. Degree of Necessity
More necessary the more inelastic, demand is relatively constant as good is required more, so despite price increase or decrease, they will continue to purchase good because of high requirement rate
Factors influencing ped- 3. Time
In the short term, less chance for consumers to change their choice and substitute to another product. In the long run, more substitutes become available and their is a greater time to be able to switch
Factors influencing ped- 4. Consumer Knowledge
If poor knowledge of substitutes, then there is greater inelasticity because less chance of switching occurring and change to QD is smaller
Factors influencing ped- 5. Prop, of disp. income
Greater the proportion the more elastic, because more to gain or lose when products increase or decrease in price
Factors influencing ped- 8. Brand loyalty
The more persuasive the advertising and the more loyal, then the lower the chance of switching to another product thus there is more inelastic ped
income elasticity of demand
measure of how much the quantity demanded of a good responds to a change in consumers’ income
Income Elasticity of demand YED=
%change in QD/%change in income
If YED is between 0 and 1
necessity good, a change in income doesn’t change QD considerably, shifts in demand are low
If YED is greater than 1
luxury good a change in income creates a large change in demand
If YED is less than 0
inferior good, negative as when income increases QD will fall, and when income decreases QD will rise so inverse relationship
cross-price elasticity of demand
a measure of how much the quantity demanded of one good responds to a change in the price of another good
XED =
% change in demand for good x/ % change in price for good y
If XED > 0
substitutes because as price for y increases the demand for good x will increase, and as price for y falls so too will demand for x. Consequently always positive, further from zero the stronger the substitutability
If XED < 0
Complements so a increase in price for y will decrease demand for x and a fall in price for y will increase demand for x so inverse relationship
If XED = 0
unrelated goods
Factors influencing YED
Whether the good is a necessity or a luxury
Standard of living (for the country)
Health of the economy
Luxuries effect on yed
As incomes rise, consumers will move towards spending more of their income on luxuries
Standard of living effect on yed
Wealthier countries are likely to have consumers with higher disposable incomes
Therefore, consumers are likely to use some of this income to buy luxury goods and services
As a result, firms will produce ‘superior’ products that meet the needs of these consumers
Health of the economy effect on yed
When the economy is declining, disposable incomes fall
Therefore, consumers spend a reducing prop. of their income on luxury goods, moving to necessities and then inferior goods
