Price, Income And Cross Elasticities Of Demand 3.2 Flashcards
What is price elasticity of demand ?
The price elasticity of demand is the responsiveness of a change in demand to a change in price.
What is the formula for price elasticity of demand ?
PED = % change in QD / % change in price
What factors affect price elasticity of demand ?
Necessity
Substitutes
Addictiveness or habitual consumption
Proportion of income spent on goods
Durability of the good
Peak and off peak demand
How does necessity affect PED ?
A necessary good such as good or electricity, will have relatively inelastic demand as even if the price increases consumers still need food and electricity. Luxury goods such as flights are relatively inelastic, if price increases demand is likely to fall
How do substitutes affect PED ?
If a good has several substitutes, such as android phones instead of apple phones, then demand is more price elastic because if price increases many people will switch to the cheaper option
How do addictiveness or habitual consumption effect PED ?
The demand for goods such as cigarettes is not sensitive to change in price because consumer become addicted to them, and therefore continue demanding the cigarettes, even if price increases
How does proportion of income spent on goods affect PED ?
If the good only takes up a small proportion of income, such as magazines which increases in price from £1.50 to £2, demand is likely to remain relatively inelastic. If the good takes up a significant proportion of income like a car rising from £15000 to £20000, the demand will be more price elastic
How does durability of the good effect PED ?
A good which lasts for a long time, such as a washing machine, has more elastic demand because consumers wait to buy another one
How does peak and off peak demand effect PED ?
During peak times, such as 9am to 5pm train tickets prices, the demand for tickets will more more price inelastic
What effect does tax revenue have on elasticity of demand ?
If a firm sells a good with inelastic demand, they’re likely to put most of the tax burden on the consumer, because they know that increasing the price will not cause demand to fall significantly
If a firm sells a good with elastic demand, they’re likely to take most of the tax burden upon themselves. This is because they know if the price of the good increases, demand is likely to fall, which lowers their revenue. This form of government intervention is not as effective at raising government revenue than inelastic tax however if governments want to reduce demand for a particular good it is effective
What effect does PED have on total revenue ?
Total revenue is equal to average prices times quantity sold
If a good has inelastic demand, the firm can raise the prices, and quantity sold won’t fall significantly. This will increase total revenue
If a good has elastic demand and the firm raises its price, quantity sold will fall. This will reduce total revenue
What is income elasticity of demand ?
Income elasticity of demand is the responsiveness to a change in demand to a change in income
What is the formula for income elasticity of demand ?
YED = % change in QD / % change in income
What are inferior goods ?
Inferior goods are those which see a fall in demand as income increases. For example the ‘value’ options at a supermarket could be seen as inferior. As income increases, consumers switch to branded goods
What are normal goods ?
With normal goods, demand increases as income increases
