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Economics > Price, Income and Cross Elasticities of Demand > Flashcards

Price, Income and Cross Elasticities of Demand Flashcards

1
Q

What is the theory?

A

Elasticity theory looks at the sensitivity of one variable in relationship to another

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2
Q

How do we work out percentage change?

A

Change/Original x 100

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3
Q

What is an elasticity coefficient?

A

The measure of the response of one variable to changes in another variable e.g If price increases by 5% demand might decrease by 15%
-The elasticity coefficient is given by -15%/+5% = -3

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4
Q

What does Price Elasticity of Demand (PED) measure?

A

The responsiveness of demand to a change in price

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5
Q

How is PED calculated?

A

rice elasticity of demand = %age change in qd/%age change in price
qd= Quantity demand

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6
Q

What does a perfectly inelastic product have a coefficient of?

A

0

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7
Q

What happens to the quantity demanded if price changes, with a perfectly inelastic product?

A

If price was to change the quantity demanded would not be affected

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8
Q

What coefficient does a price inelastic product have?

A

A price inelastic product will have a PED coefficient between 0 and -1

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9
Q

What happens to demand if the price changes with a price inelastic product?

A

If price was to change the quantity demanded would change by a lesser amount

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10
Q

What does a price elastic product have a coefficient of?

A

A price elastic product will have a PED coefficient between -1 and ∞

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11
Q

What happens to demand if price changes with a price elastic product?

A

If price was to change the quantity demanded would change by a greater amount

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12
Q

What does a perfectly elastic have a coefficient of?

A

A perfectly elastic product will have a PED coefficient of ∞

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13
Q

What happens to quantity demanded when the price of a perfectly elastic product changes?

A

If price was to change the quantity demanded would be infinite

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14
Q

What are changes in total expenditure influenced by?

A

PED

  • If PED is elastic i.e. >1 a rise in price will cause total expenditure to fall and vice versa
  • If PED is inelastic i.e. <1 a rise in price will cause total expenditure to rise and vice versa
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15
Q

What is price elasticity determined by?

A

Substitutes- The number and closeness of available substitutes will help to determine PED
-If there are no close or lack of available substitutes the product is likely to be very price inelastic and vice versa

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16
Q

What is the definition of a market?

A

As we widen the market so PED becomes more inelastic

  • For example, cigarettes are very price inelastic as there are no close substitutes
  • However, the demand for specific brands of cigarette will have a higher PED
17
Q

What is income elasticity of demand?

A

Income elasticity of demand (YED) is a measure of the responsiveness of demand to a change in income

18
Q

How do we work out income elasticity of demand?

A

Income elasticity of demand = %age change in qd/%age change in income

19
Q

What is YED determined by?

A

Whether the good is a necessity or a luxury
-At higher standards of living increased consumer incomes see additional demand tend towards luxury goods as demand for necessities is satiated

20
Q

Are wealthier countries likely to have higher or lower standards of living?

A

Higher

21
Q

What is cross-elasticity of demand?

A

Cross-elasticity of demand (XED) is a measure of the responsiveness of demand for one good x to a change in price of nother good y.

22
Q

How so we work out XED?

A

Cross elasticity of demand = %age change in quantity of A/%age change in price of B

23
Q

What is XED determined by?

A

Whether the product is a: Substitute

  • Substitutes will have a positive cross-elasticity of demand
  • As the price of good Y increases (positive) the demand for good X will increase (positive)
  • Close substitutes will have a higher XED as consumer demand for good X will be more sensitive to a change in price of good Y
24
Q

What is a complement?

A
  • 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 as consumer demand for good X will be more sensitive to a change in price of good Y
25
Q

What will firms do?

A

Attempt to change the cross-elasticity of their products

26
Q

How will firms attempt to change XED?

A

Substitutes
Firms will try to differentiate their products from the competition
Complements
Firms will produce a range of complements to accompany their core products

27
Q

What factors determine PED?

A 
Substitutability
Percentage of income
Type of good
The width of the market definition
Time
28
Q

What is Substitutability?

A

The most important determinant of PED.
-When a substitute exists for a product consumers, respond to a price rise by switching spending away from the good and buying a substitute whose price has not risen

29
Q

What is Percentage of Income?

A

The demand for goods or services on which households spend a large proportion of their income tend to be more elastic than those small items that account for only a small fraction of income

30
Q

What are necessities or luxuries?

A

It is sometimes said that demand for necessities are price inelastic whereas luxury goods are elastic. However if no substitute exists then demand for a luxury good may be inelastic and if there are available substitutes for necessities then they would be elastic

31
Q

What is the width of the market?

A

The lower the PED. The demand for bread produced by a certain baker is likely to be more elastic than the demand for bread produced by all bakers. Other bakeries are providing a number of close substitutes. This can be stretched further

32
Q

What is time?

A

For many goods and service demand is more elastic in the LR than the SR because it takes time to respond to a price change

33
Q

What are the rules of PED elasticity?

A
  • If total consumer spending increases in response to a price fall, demand is elastic
  • If total consumer spending decreases in response to a price fall, demand is inelastic
  • If consumer spending remains constant to a price fall then it is neither elastic or inelastic - unit elastic

Economics (16 decks)

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