Price/ income/ cross elasticities of demand 1.2.3

What is price elasticity of demand?

Measures the responsiveness of the quantity demanded of a good or service to changes in its price

How to calculate PED?

PED = % change of quantity / % change in price

What are key factors effecting price elasticity of demand?

• Number of close substitutes

• Cost of switching suppliers

• Degree of necessity for consumers

• Time frame available when making a choice

• Strength of consumer brand loyalty

• Percentage of income spent on the product

• Habitual demand

• Peak and Off-peak demand

What is the coefficient of PED when demand is price elastic?

Greater than one

What happens when a demand is price elastic?

A small change in price leads to a relatively large change in the quantity demanded

What is the coefficient of PED when demand is price inelasic?

Less than one

What happens when demand is price inelastic?

A change in price causes a smaller change in quantity demanded. Consumers are less sensitive to price changes

What is a perfectly inelastic curve?

implies that consumers are willing and able to pay any price for the product

What is a perfectly elastic demand curve?

A change in supply will NOT lead to any change in the equilibrium market price

What is the coefficient of PED when demand is perfectly inelastic?

PED = 0

What is the coefficient of PED when demand is perfectly elastic?

PED = ∞

When does unitary elastic occur on the demand curve?

At the halfway point

Where does PED CHANGE on the demand curve?

changes along a demand curve

What used to calculate PED?

Proportionate changes NOT absolute changes

What can firms use PED to predict?

• The effect of a change in price on total revenue of sellers

• Price volatility in a market following changes in supply

• Effect of a change in an indirect tax on price and quantity demanded

• Whether a business is able to pass on some or all of tax onto consumers

What are some reasons for dynamic/ surge pricing?

• Normal peak hours

• Bad weather conditions

• Events

• Traffic conditions

What is surge pricing?

Algorithmically fueled technique that is used when here is a demand-supply imbalance

What are some limitations of PED?

• Problems with inaccurate or incomplete or complex data collection

• Consumer price sensitivity changes over time

• Elasticity of demand varies by region/ time

• Not all businesses are profit maximisers

• Rival producers will change their market strategies from time to time

What is Income elasticity of demand?

Measure the relationship between a change in quantity demanded for good X and a change in consumer real income

How to calculate YED?

YED = % change in quantity demanded / % change in real income

What is the elasticity of a normal good?

Positive income elasticity- YED > 0

What is the elasticity of luxury goods?

YED > 1

What is the elasticity of necessities?

0 < YED < 1

What is the elasticity of inferior goods?

Negative income elasticity. YED < 1

What are some inferior goods?

• own-label brands

• Urban bus transport

• Cigarettes

• Economy class travel

• Own-label cereals

• Economy Foodstuffs

What characterises an inferior good?

When real income increase during a period of economic growth, demand for inferior goods decreases causing an inward shift of the demand curve.

What does knowledge on YED help businesses do?

To predict the effect of changes in the (macro) economic cycle on their sales

What is the cross elasticity of demand?

Measures the responsiveness of the quantity demanded of one good to a change in price of another related good.

How to calculate XED?

XED = % change in quantity demanded of A / % change in price of B

What is the XED of a substitute?

Have a positive XED- an increase in price of one product will lead to a rise in demand for a substitute.

The higher the value of XED, the closer the products are as substitutes,

What is the XED of a compliment?

Have a negative XED- an increase in price of one product results in a decrease in quantity demanded of a compliment.

The lower the value of XED, the closer the products are as compliments