Price, income and cross elasticities of demand Flashcards
What is the formula for percentage change?
- Change in value divided by original value multiplied by 100.
What is an elasticity coefficient?
- The measure of the response of one variable to a change in another variable.
What is Price Elasticity of Demand?
- It measures the responsiveness of demand to a change in price.
What is the PED formula?
- The percentage change in quantity demanded divided by the percentage change in price (dinner on plate).
- %change in quantity demanded / %change in price
If the PED is 0 what is the title given?
- Perfectly inelastic.
If the PED ranges between 0<-1 what is the title given?
- Price inelastic.
If the PED is -1 what is the title given?
- Unitary (constant) elasticity.
If the PED is -1>infinity what is the title given?
- Price elastic
If the PED is infinity what is the title given?
- Perfectly elastic
If the PED is 0, what is the relevance to the business?
- Theoretically, the business can charge as high as a price as it wants to.
If the PED is between 0 and -1, what is the relevance to the business?
- As firms should raise P, D will decrease, but total revenue will increase.
If the PED is -1, what is the relevance to the business?
- Increasing or decreasing price will lead to no change in total revenue.
If the PED is -1>infinity, what is the relevance to the business?
- A firm should lower P, D will increase, but total revenue will increase.
If the PED is infinity, what is the relevance to the business?
- Theoretically, if the business increased price above a certain point, D would completely disappear.
What are the determinants of price elasticity of demand?
- SANDPIT
- Substitutes.
- Addiction.
- Necessity or luxury.
- Durability.
- Proportion of Income spent on good.
- Time
How are substitutes a determinant of price elasticity of demand?
- The number and closeness of available substitutes will help to determine PED.
- If there are no close or lack of substitutes, the product is likely to be very price inelastic and vice versa.
How is time a determinant of price elasticity of demand?
- Short-run, products are likely to be more price inelastic; consumers will find it difficult to change their shopping habits.
- Long-run, products are likely to be more price elastic as consumers adjust to changing market conditions.
How is durability a determinant of price elasticity of demand?
- An increase reliability of a product would guarantee a long-lasting and efficient necessity, therefore it could lead to an increase in demand.
How is necessity or luxury a determinant of price elasticity of demand?
- It can be said that demand for necessities is price inelastic whereas demand for luxuries is price elastic but this often depends on the availability of substitutes.
How is percentage of income a determinant of price elasticity of demand?
- People will pay more attention to changing price of ‘big ticket’ items.
- For items on which only a small amount is spent, people are unlikely to notice the change in price.
What is the Income elasticity of demand?
- A measure of the responsiveness of demand to a change in income.
What is the formula of the Income Elasticity of Demand?
- Percentage change in quantity demanded/ Percentage change in income
What would it mean if the YED is positive?
- The YED would indicate a normal good.
What would it mean if the YED is negative?
- The YED would indicate an inferior good.
What would it mean if the YED ranges from -1<x<+1?
- The good is income inelastic.
- The demand changes at a lower proportion than the increase in income.
What would it mean if the YED ranges at x<-1 or >+1?
- The good is income elastic.
- The demand changes at a higher proportion than the increase in income.
What are the determinants of income elasticity of demand?
- Whether the good is a necessity or a luxury.
- The level of income of a consumer.
- Standards of living.
- The economic cycle.
How does the good being a necessity or luxury determine the income elasticity of demand?
- At higher standards of living, increased consumer incomes lead to more purchasing of luxury goods as demand for necessities is less prioritised.
How does the level of income of a consumer determine the income elasticity of demand?
- Poorer consumers tend to spend their income on necessities.
- As wealth increases, the YED for necessities moves towards zero, consumers more satisfied with the amount of the product.
- Normal goods that are necessities will have lower positive YED coefficients.
- As consumer incomes increase, they are likely to spend some of their income on luxuries, these products have higher positive YED coefficients.
How does the standards of living determine the income elasticity of demand?
- Wealthier countries are likely to have consumers with higher disposable incomes.
- Therefore, they would have greater spending power and are likely to use some of this greater income to buy luxury goods and services.
- Firms will therefore produce superior products that meet needs of consumers.
How does the economic cycle determine the income elasticity of demand?
- When the economy is in recovery mode and leading into boom, disposable incomes increase and consumers spend a greater proportion of this increase in income, firstly on necessities and then on luxury goods.
- When the economy is in decline, the opposite occurs, and consumers move to necessities and then inferior goods.
What is the definition of the cross-elasticity of demand?
- A measure of the responsiveness of demand for one good, x to a change in price of another good, y.
What is the formula of the cross-elasticity of demand?
- Percentage change in quantity demand of good X/ Percentage change in price of good Y.
What does it mean if the XED ranges from -1 to 1?
- Cross-price inelastic.
- Demand for good X changes at a lesser proportion than the change in price of Good Y.
What does it mean when the XED is x<-1 or >+1?
- Cross-price elastic.
- Demand for Good X changes at a greater proportion than the change in price of Good Y.
What are the determinants of the cross-elasticity of demand?
- Substitutes
- Complements
- Has no relationship
How do substitutes become an influencing factor of the XED?
- Substitutes will have a positive XED.
- As the price of good Y increases (positive), the demand for good X will increase (positive).
- Close substitutes will have a higher XED (elastic) as consumer demand for good X will be more sensitive to a change in price of good Y.
How do complements become an influencing factor of the XED?
- Complements will have a negative cross-elasticity of demand.
- As the price of Good Y increases (positive), the demand for good X will decrease (negative).
- Close complements will have a higher XED (elastic) as consumer demand for good X will be more sensitive to a change in price of Good Y.
How do two goods that have no relationship an influencing factor of the XED?
- The change in price of Good X will have no impact on the demand for Good Y.
- XED will be 0.
What will firms do about substitutes to change the cross-elasticity of demand?
- Firms will try to differentiate their products from the competition.
- This is done through advertising and branding of the product; consumers would be less likely to switch to competitor’s products.
- A firm with plenty of close substitutes will be less able to increase its prices.
What will firms do about complements to change the cross-elasticity of demand?
- Firms will produce a range of complements to accompany their core products.
- A firm that sells a range of complements is likely to increase total revenue.
