Price Income, And Cost Elasticities Of Demand Flashcards
What does the law of demand state
The law of demand states that when there is an increase in price, there will be a fall in quantity demanded
What is price elasticity of demand
Price elasticity of demand reveals how responsive the change in quantity demanded is to a change in price
How do you calculate PED
% change in quantity demand / % change in price
How do you interpret PED values
0 Perfectly Inelastic
The QD is completely unresponsive to a
change in P (very theoretical value e.g. heart transplant is extremely inelastic but possibly not perfectly)
0→1 Relatively Inelastic
The %∆ in QD is less than proportional
to the %∆ in P (e.g. addictive products)
1 Unitary Elasticity
The %∆ in QD is exactly equal to the %∆ in P
1→ ∞ Relatively Elastic
The %∆ in QD is more than proportional
to the %∆ in P (e.g. luxury products)
∞ Perfectly Elastic
The %∆ in QD will fall to zero with any
%∆ in P (highly theoretical elasticity)
What are the determinants of PED
Availability of substitutes: good availability of substitutes results in a higher value of PED (relatively elastic)
Addictiveness of the product: addictiveness turns products into necessities resulting in a low value of PED (relatively inelastic)
Price of product as a proportion of income: the lower the proportion of income the price represents, the lower the PED value will be. Consumers are less responsive to price changes on cheap products (relatively inelastic)
Time period: In the short term, consumers are less responsive to price increases resulting in a low value of PED (relatively inelastic). Over a longer time period consumers may feel the price increase more and will then look for substitutes resulting in a higher value of PED (relatively elastic)
What is YED
Changes in income result in changes to the demand for goods/services
Income elasticity of demand (YED) reveals how responsive the change in quantity demanded is to a change in income
How do you calculate YED
% change in quantity demanded / % change in income
How do you analyse values of YES
The YED value can be positive or negative and the value is important in determining the type of good
0→1 Normal necessity
Demand increases when income increases. Income inelastic which means that it is relatively unresponsive to a change in income
YED > 1
Normal luxury
Demand increases when income increases. Income elastic which means that it is relatively responsive to a change in income
YED < 0
Inferior Good
Demand decreases when income increases
What are factors that influence YED
YED is influenced by any factors in an economy which change the wages of workers
During a recession wages usually fall and demand for inferior goods rises and luxury goods falls
During a period of economic growth and rising wages, demand for luxury goods increases and demand for inferior goods decreases
Other influences on income include minimum wage legislation, taxation, increased international trade
What is cross price elasticity of demand (XED)
Changes in the prices of complementary goods and substitutes affect the demand for related products
Cross price elasticity of demand (XED) reveals how responsive the change in quantity demanded for good A is to a change in price of good B
How do you calculate XED
% change in quantity demanded of good A/ % change in price of good B
How would you interpret XED values
XED < 0
Complementary goods
The negative value indicates the two goods are complements
The higher the value the stronger the relationship
XED > 0
Substitutes
The positive value indicates the two goods are substitutes
The higher the value the stronger the relationship
XED = 0
Unrelated goods
A value of zero indicates that there is no relationship between the two goods.
The closer to zero the weaker the relationship is
Why is knowledge of PED important to firms
Knowledge of PED is important to firms seeking to maximise their revenue
If their product is price inelastic in demand, they should raise their prices
If price elastic in demand, then they should lower their prices
Why is knowledge of PED important to government
Knowledge of PED is important to Governments with regard to taxation and subsidies
If they tax price inelastic in demand products, they can raise tax revenue without harming firms too much
Consumers are less responsive to price changes so firms will pass on the tax to the consumer
If they subsidies price elastic in demand products, there can be a greater than proportional increase in demand
Why is knowledge of XED important to firms
Knowledge of XED is important to firms as they seek to maximise their revenue
It can help them to adjust pricing strategies for substitute and complementary goods
It can help them understand the likely impact of competitors’ pricing strategies on their sales
