Price, Income and Cross Elasticities of Demand

Question 1

Price Elasticity of Demand shows how Demand changes with Price

Answer 1

1. Price elasticity (PED) is a measure of how the quantity demanded of a good responds to a change in its price
2. PED can be calculated using the following formula:
   PED = percentage change in quantity demanded/ percentage change in price
   LOOK AT EXAMPLE IN BOOK
3. Price elasticity of demand is usually negative because demand falls as price increases for most goods

Question 2

PED can be elastic, inelastic or Unit elastic

1. Elastic PED

Answer 2

ELASTIC:

1. If the value of the PED is greater than 1, demand for the good is elastic. This means a percentage change in price will cause a larger percentage change in quantity demanded.
2. The higher the value of PED, the more elastic demand is for the good.
3. In diagram 1 price falls from £50 to £40 and an extra 45 units are demanded, which gives an elastic PED of -7.5
4. Perfectly elastic demand has a PED of +_ infinity and any increase in price means that deamnd willl fall to zero - see diagram 2. Consumers are willing to buy all they can obtain at P, but none at a higher price.

Question 3

2. Inelastic PED

Answer 3

INELASTIC

1. The value of PED for goods with inelastic demand is between 0 and 1. This means percentage change in price will cause a smaller percentage change in quantity demanded. The smaller the value of PED, the more inelastic demand is for the good.
2. In diagram 3, price falls from £50 to £40 and only and extra 4 units are demanded. This gives an inelastic PED of -0.4 which means for every 1% of change in price then a 0.4% change in demand.
3. Perfectly inelastic demand has a PED of 0 and a change in price will have no effect on the quantity demanded - diagram 4. At any price, the quantity demanded will be the same.

Question 4

3. PED Unit Elasticity of Demand

Answer 4

UNIT ELASTICITY OF DEMAND

1. A good has unit elasticity if the size of the percentage change in price is equal to the size of the percentage change in quantity demanded - diagram 5
2. For example if a 20% increase in price will lead to a 20% increase in quantity demanded

Question 5

Income elasticity of demand shows how demand changes with income

Answer 5

1. Income elasticity of demand (YED) measures how much the demand for a good changes with a change in real income
2. YED can be calculated using the following formula:
   YED = percentage change in quantity demanded of a good/ percentage change in real income
3. LOOK AT PAGE 19 for examples

Question 6

You need to know about Cross Elasticity of Demand too

Answer 6

1. Cross elasticity of demand (XED) is a measure of how the quantity demanded of one good responds to a change in price of another good
2. The XED can be calculated using the following formula:
   XED = percentage change in quantity demanded of good A/ percentage change in price of good B
3. If two goods are substitutes their XED will be positive and if they’re complements their XED will be negative.
   LOOK AT EXAMPLES IN TEXTBOOK