Theme 1.2.3 (price, income and cross elasticities of demand)

Price Elasticity of demand (PED)

PED measures the responsiveness of quantity demanded to a change in a goods prices

How do you calculate PED?

% change in quantity demanded : % change in price

What does it mean if PED is more than 1

Demand is elastic

What does it mean if PED is less than 1

Demand is inelastic

What does it mean if PED equals 1

Demand is unitary elastic

What is elastic demand

Quantity demanded changes proportionately more than price

What is inelastic demand

Quantity demanded changes proportionately less than price

What happens to demand when the price of an elastic product increases?

Quantity demanded falls significantly

What happens to demand when the price of an inelastic product increases?

Quantity demanded falls only slightly

Example of inelastic demand

Petrol, electricity, or essential medicine

Example of elastic demand

Holiday, restaurant meals, or luxury goods

Why is petrol often price inelastic?

Consumers may still need petrol, so there are fewer substitutes in the short run

Why are luxury goods often price elastic?

Consumers can delay buying them or choose cheaper alternatives

What does PED of 0 mean

Demand is perfectly inelastic, quantity demanded does not change when price changes

What does PED of infinity mean?

Demand is perfectly elastic a tiny price increase causes quantity demanded to fall to zero

Key difference between elastic and inelastic

Elastic demand changes a lot when price changes

Inelastic demand changes a little when price changes

What does PED tell a business

how strongly customers will respond to change in price

What does YED stand for?

Income elasticity of demand

What is YED

How responsive quantity demanded is to a change in consumer income

How do you calculate YED?

YED = % change in quantity demanded : % change in income

What does a positive YED mean

Demand Increases when income increases. The good is a normal good

What does negative YED mean?

Demand decreases when income increases. The good was an inferior good

What does YED > 1 mean

Demand is income elastic

What does 0 > YED < 1 mean

Demand is income inelastic

What does YED < 0 mean

The good is inferior

What is a necessity

A good between YED 0-1 meaning demand increases less whilst income rises

Give example of a luxury and a necessity in YED

Luxury holidays

Basic food

Why is YED helpful to businesses

It helps businesses predict how demand for their products will change when consumer incomes change

What does XED stand for

Cross elasticity of demand

What is XED

it’s how responsive the demand for one good is to a change in the price of another good

How to calculate XED

XED = % change in quantity demanded of good A : % change in price of good B

What does positive XED mean

The goods are substitutes

What does negative XED mean

The goods are compliments

What does an XED of zero mean

The goods are unrelated

What are substitute goods

Goods that can be used instead of eachother: Pepsi and Coke, Netflix and Disney +

What are complementary goods

Goods that are used together: cars and petrol, printers and ink

Why is XED useful for businesses

Helps businesses understand how competitors prices or complementary products prices could affect their own demand