Price and Income Elasticity of Demand

These flashcards cover key concepts related to price and income elasticity of demand, including definitions, examples, and formulas.

Price elasticity of demand (Eₚ) formula

Eₚ = % change in Q / % change in P = ΔQ/Q / ΔP/P.

What does price elasticity of demand measure?

The percentage change in quantity demanded resulting from a 1% change in price.

Perfectly inelastic demand

Eₚ = 0; quantity demanded does not change when price changes (e.g., lifesaving medicine).

Inelastic demand

0 > Eₚ > -1; quantity changes less than proportionally to price (e.g., gasoline).

Elastic demand

Eₚ < -1; quantity changes more than proportionally to price (e.g., recreation).

Perfectly elastic demand

Eₚ = -∞; consumers buy only at one price; any price increase drops demand to zero.

Veblen good

Eₚ > 0; higher prices increase demand (seen as a status symbol, e.g., luxury goods).

Giffen good

Eₚ > 0; price increase leads to higher demand due to a strong income effect (e.g., low-quality staple foods).

Factors affecting price elasticity

Degree of necessity, availability of substitutes, and search costs.

Elasticity difference between firm and market level

A firm’s demand may be elastic, while aggregate demand for the good may be inelastic.

Elasticity in the long run vs. short run

Goods are more elastic in the long run as people and firms can adjust behavior.

Income elasticity of demand (Eᵧ) measurement

How quantity demanded changes with a change in income.

Normal good

Eᵧ > 0; demand increases as income increases.

Inferior good

Eᵧ < 0; demand decreases as income increases (e.g., low-quality foods).

Necessities

1 > Eᵧ > 0; demand rises with income but less than proportionally (e.g., clothing).

Luxuries

Eᵧ > 1; demand rises more than proportionally with income (e.g., jewelry).