1.2.3 Price, income and cross elasticities of demand

Definition of price elasticity of demand (PED)

The responsiveness in the demand for a good due to change in its price

Formula for PED

Interpret numerical values of price elasticity of demand

Interpret numerical values of price elasticity of demand 2

The relationship between price elasticity of demand & total revenue (including calculation)

Total revenue = total amount of money received by producers from selling a given quantity of a good / price per unit of goods x quantity sold

If demand is price elastic:

Price increases, quantity demanded decreases, total consumer spending decreases, total revenue decreases

If demand is price inelastic:

Price increases, quantity demanded not affected, quantity sold stays relatively the same, Revenue increases

Definition of income elasticity of demand

The responsiveness of demand for a good/service to a change in real income

Formula of income elasticity of demand

Interpret numerical values of income elasticity of demand

• Normal goods (positive) - as income increases, quantity demanded increases

  • Luxury: YED more than 1

  • Necessity: YED in between 0 & 1

• Inferior goods (negative) - as income increases, quantity demanded decreases, therefore, quantity sold decreases with the same price causing sales revenue to decrease

Definition of cross elasticities of demand

Responsiveness of demand for good A given a change in price of good B

Formula to calculate cross elasticities of demand

Interpret numerical values of cross elasticity of demand

• Substitute goods: XED positive (if XED is more than 1 - indicates a close substitute)

  • In competitive demand

• Complementary goods: XED negative

  • In joint demand

• Unrelated goods: XED = 0

The factors influencing elasticities of demand

• Availability of substitutes

• Luxury & necessity goods

• Proportion of income spent on the good

Evaluation point:

• PEDs are forecast, estimate

• Time period