Economics 1.2.3

Price, income and cross elasticities of demand

What is the PED and what is its formula?

PED measures the responsiveness of the quantity demanded to a change in price.

% CHANGE IN Q / % CHANGE IN P

What is YED and what is its formula?

YED measures the responsiveness of the quantity demanded to changes in consumer income.

% CHANGE IN Q / % CHANGE IN Y

What is XED and what is its formula?

XED measures the responsiveness of the quantity demanded of one good to changes in the price of another.

% CHANGE IN Q OF GOOD A / % CHANGE IN P OF GOOD B

Interpretations of numerical values of PED

Unitary elasticity- (PED=1) percentage change in quantity demanded is exactly proportional to the percentage change in price.

Perfectly elastic- (PED=∞) Quantity demanded is extremely responsive to price changes.

Perfectly inelastic- (PED=0) Quantity demanded does not respond to change in price

Relatively elastic- (PED>1) Demand is responsive to price changes.

Relatively inelastic- (0<PED<1) Demand is less responsive to price changes.

Interpretations of numerical values of YED

Inferior goods- (YED<0) Demand increases as income decreases

Normal goods- (0<YED<1) Demand increases with income but at a decreasing rate

Luxury goods- (YED>1) Demand increases significantly with income

Interpretations of the numerical value of XED.

Substitutes (XED>0) - an increase in the price of one good leads to an increase in the demand of the other.

Complementary goods (XED<0) - an increase in the price of one good leads to a decrease in the demand of the other.

Unrelated goods (XED=0) - The price change of one good has no effect on the other.

What are the factors affecting the elasticities of demand?

Availability of substitutes, necessity vs luxury, time horizon and habits.

What is the significance of the elasticities of demand to firms?

Setting prices and predicting revenue changes

Elastic demand, price increases, revenue decreases

What is the significance of the elasticities of demand to a government?

To help make tax and subsidy decisions

Inelastic goods can bear higher taxes whereas elastic goods may suffer a decrease in demand due to price increases.

Subsidies can encourage the consumption of essential goods.