Price, income and cross elasticities of demand

Question 1

define price elasticity of demand (PED)

Answer 1

measures how much quantity demanded will respond to a change in price

Question 2

how do we calculate PED

Answer 2

% change in QD/ %change in P

Question 3

how do we work out percentage change

Answer 3

change/ original x 100

Question 4

is the PED for a goods negative

Answer 4

yes

Question 5

why are PED’s negative for a good

Answer 5

demand has an inverse relationship, so:
(p decrease, QD increase)
- p decreases = percentage change in price will be negative
- QD increase = percentage change in QD will be positive
- Overall this will produce a negative PED
- vice versa

Question 6

define elastic demand
-state features of elastic demand

Answer 6

where consumer are very responsive to changes in price
- PED is between -1 and - infinity
- the % change in QD is bigger than the % change in P

Question 7

define inelastic demand and state features

Answer 7

where consumer are unresponsive to changes in price.
- PED is between between -1 and 0
- the % change in QD is smaller than the % change in price

Question 8

define unitary elastic demand and state what PED unitary elastic demand will have

Answer 8

where the % change in QD is the same as the % change in price
- PED is equal to -1

Question 9

define perfectly inelastic demand

Answer 9

when price has no effect on QD
- we reach zero
- as Inelastic as we can be

Question 10

define perfectly elastic demand

Answer 10

a demand which falls to zero when price changes
- means if we tried to change the price at all, consumers would respond infinitely = switch over to a cheaper alternative

Question 11

state the 6 factors which influence PED

Answer 11

1. Necessity
2. Addiction & habit
3. Availability of substitutes
4. Brand loyalty
5. Proportion of income
6. Time period
   (NASBIT)

Question 12

factors influence PED: Necessity vs luxury

Answer 12

Necessity is something we need, we need it to live our lives
- inelatic, we will be unresponsive to price changes as we need the services or good

Luxury is something we do not need, but it is nice to have if a consumer can afford it
- luxury goods are elastic, we will be responsive to price changes price

Question 13

factors influence PED: Addiction & habit

Answer 13

When people get into the habit of consuming certain things like coffee and junk food or video games, they can get addicted.
- Habit forming products are likely to have inelastic demand because once a consumer is hooked, they cannot break their habitual behaviour and so they will continue to demand even if the price changes a lot

Question 14

factors influence PED: define subsitutes and state how Availability of substitutes will effect elasticity

Answer 14

A substitute is a product which can replace another product e.g. a Samsung and an iPhone.
- Many substitutes = elastics
- if the price of one good were to increase, consumers could very easily switch over to other types of good/service, so demand would be responsive to changes in price, suggesting elastic demand.

• few substitutes = inelastic
• if the price of one good or service were to change they would have to continue to demand the G/S, so demand would not be responsive to the change in price

Question 15

factors influence PED: Time period

Answer 15

In the long run, consumers have time to respond and find a substitute, so demand becomes more price elastic vs short run, consumers do not have this time, so demand is more inelastic.

Question 16

factors influence PED: Proportion of income

Answer 16

larger proportion of income = elastic demand
- will have a significant impact on the consumer, so they’ll be very responsive to this change in price

Small proportion of income = inelastic demand
- little impact on consumers, so they’ll be less responsive to changes in price

Question 17

factors influence PED: Brand loyalty

Answer 17

Brand loyalty is how loyal consumers are to a brand and how strong the branding of a product is
- Strong brand loyalty = inelastic
- if its price changes, consumers don’t look to buy aG/S for its price, they look to buy G/S for its brand, its design, its engineering; consumers are therefore unlikely to be responsive to changes in the price

• Weak brand loyalty = elastic demand
• Consumers typically look to buy G/S for their cheap, affordable price so they’re more concerned with the gs’s price
• if the price were to change, consumers will be very responsive

Question 18

does Elasticity also changes in the long and short run

Answer 18

yes

Question 19

define income elasticity of demand (YED)

Answer 19

measureshow muchquantity demanded will respond to a change in income

Question 20

how do you calculate YED?

Answer 20

% change in QD / % change on Y

Question 21

after doing your elasticity calculation, do you put a percentage sign at the end of the answer, yes or now

Answer 21

no

Question 22

why can YED take a positive and negative value? And state which would be positive or negative

Answer 22

because of inferior goods and normal goods
- inferior = negative YED
- normal = positive YED

Question 23

why do inferior goods take a negative YED

Answer 23

• If income falls for an inferior good(Y=negative), QD will increase (QD=positive)
• if incomes rise (Y=positive), QD of inferior goods will decrease (QD=negative)

Question 24

why do normal goods take a positive YED

Answer 24

• if incomes increase (Y=positive), QD of normal goods will increase (QD=positive)
• If incomes fall (Y=negative), QD will decrease (QD=negative)

Question 25

state the two categories economists split normal goods into

Answer 25

income elastic and income inelastic

Question 26

what is an income elastic good?
- state aspects of income elastic goods

Answer 26

when the % change in QD is bigger than % change in income
(Small changes in income = bigger changes in QD)
- usually luxury goods e.g. holidays, where consumers have more income
- have a YED between 1 and infinity

Question 27

what is an income inelastic good?
- state aspects of income inelastic goods

Answer 27

when the %change in QD is smaller than %change in income
- usually necessities e.g. milk, goods we are already demanding as we need them to get by, so when incomes rise we are only going to demand a smaller %
- YED is between 0 and 1

Question 28

Define cross elasticity of demand

Answer 28

Measures how quantity demand of one good (good A) responds when the price of another good (good B) changes.

Question 29

How do you calculate cross elasticity of demand (XED)

Answer 29

% change in QD of good A / % change in P of good B

Question 30

Why is XED sometimes positive and negative, state which property is positive or negative

Answer 30

Because of Complements and substitutes
- compliments = negative XED
- substitutes = positive XED

Question 31

Why do compliments have a negative XED

Answer 31

• if the price of good B decreases percentage change in price will be negative, the %change in QD of good A will be positive. Overall our XED will be negative
• If the price of good B increases, %change of price of good B will be positive. This means QD of good B will decrease as consumer switch away from good B - can’t afford = % change in QD of good A will be negative

Question 32

Why do substitutes have a positive XED?

Answer 32

• if price of good B increases, the %change in price will be positive. For substitutes, the quantity demanded of good A will increase - consumers will switch over to good A, increasing the QD. Overall XED will be positive
• If price of good B decreases, the %change in price of good B will be negative. When price of a substitute good goes down people will demand less of the good A because the are busy buying cheaper good B instead = %change in QD will be negative

Question 33

What does unrelated goods mean?

Answer 33

means a change in price of one of the goods has no effect on the quantity demanded of the other.

Question 34

When do we have unrelated goods?

Answer 34

When XED is 0