1.2.3 Price, Income and Cross Elasticities of Demand

Price Elasticity of Demand (PED)

Measures the responsiveness of the quantity demanded to changes in the price of a good. Formula:PED = (% Change in Quantity Demanded) / (% Change in Price)

Income Elasticity of Demand (YED)

Measures the responsiveness of the quantity demanded to changes in consumer income. Formula:YED = (% Change in Quantity Demanded) / (% Change in Income)

Cross Elasticity of Demand (XED)

Measures the responsiveness of the quantity demanded of one good to changes in the price of another. Formula:XED = (% Change in Quantity Demanded of Good A) / (% Change in Price of Good B)

Unitary Elastic (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, demand is perfectly elastic.

Perfectly Inelastic (PED = 0)

Quantity demanded does not respond to price changes, demand is perfectly inelastic.

Relatively Elastic (PED > 1)

Demand is responsive to price changes.

Relatively Inelastic (0 < PED < 1)

Demand is less responsive to price changes.

Inferior Goods (YED < 0)

Demand decreases as income increases (e.g., low-quality goods).

Normal Goods (0 < YED < 1)

Demand increases with income but at a decreasing rate.

Luxury Goods (YED > 1)

Demand increases significantly with income (e.g., luxury cars).

Substitutes (XED > 0)

An increase in the price of one good leads to an increase in the quantity demanded of the other (e.g., Coke and Pepsi).

Complementary Goods (XED < 0)

An increase in the price of one good leads to a decrease in the quantity demanded of the other (e.g., cars and gasoline).

Unrelated Goods (XED = 0)

The price change of one good has no effect on the other.

Availability of substitutes, necessity vs

Firms use elasticities to set prices and predict revenue changes.

Elastic demand means price increases reduce total revenue, while inelastic demand means price increases raise total revenue.

Government uses elasticities to make taxation and subsidy decisions.

Inelastic goods can bear higher taxes, while elastic goods may see reduced consumption due to taxes.

Subsidies can encourage the consumption of essential goods.