Elasticities of demand Flashcards
Define Price Elasticity of demand?
PED measures the responsiveness of quantity demanded to a change in the price of the good or service.
What is the formula for PED?
PED = %change in quantity demand / % change in price
What’s on the bottom and why?
Price, because quantity is on the top
What’s on the top and why?
Quantity, because price is on the bottom
Determinants of PED?
- SUBSTITUTES
- the availability of substitutes
- HABITUAL
- whether consumption is habitual
- INCOME
- the proportion of income spent on good or service
- TIME
- the time period for consumers to adjust to spending patterns
When is PED elastic?
If PED is > 1 it is elastic.
What does an elastic PED mean?
It means that the % change in quantity demanded is greater than the % change in price
When is PED inelastic?
If PED is < 1 it is inelastic
What does an inelastic PED mean?
IT means that the % change in quantity demand is less than the % change in price
When is PED perfectly inelastic?
If PED=0 then it is perfectly inelastic
When is PED unitary?
When PED=1
What does it mean when PED is unitary?
It means that the % change in quantity demanded is equal to the % change in price
What are limitations of the PED?
- PED’s are generally estimates and may not be accurate
- PED’s may change over time
- PED’s assume ceteris paribus to other determinants of demand
Define Cross elasticity of demand?
XED measures the responsiveness of demand for one product in relation to a change in the price of another product
What is the XED formula?
XED= %change in quantity demanded of Product A / % change in price of product B
What does a positive XED mean?
It means that the two goods are substitutes
What does a negative XED mean?
It means that the two goods are compliments
Define Income Elasticity of demand?
The responsiveness of demand of a good or service when income changes
What is the YED formula?
YED= %change in quantity demanded / % change in income
What does a positive YED mean?
A positive YED means that the product is a normal good
What does a negative YED mean?
A negative YED means that the product is an inferior good
How is YED relevant in business?
- YED estimates can be very useful to a firm when planning changes in output and productive capacity as well as changes in employment and stocks
- Estimates of YED enable a firm to forecast future market demand
- In an economic boom, firms can expect rise in the demand for normal goods and a fall in a recession
How is XED relevant in business?
-XED estimates can be very useful to a firm when planning changes in output, employment and stocks in response to changes in the price of substitutes or compliments.