3). Price, income and cross elasticities of demand

• What is Elasticity?

  Elasticity refers to the responsiveness or sensitivity of a variable to changes in another variable. It measures the percentage change in one variable in response to a percentage change in another variable. It is commonly used to measure the extent to which demand will change.
• What is Price Elasticity of Demand (PED)?

  A measure of the sensitivity of the quantity demanded to change in the price of a good or service -> The responsiveness of demand to changes in price.
• What is Income Elasticity of Demand (YED)?

  A measure of the sensitivity of the quantity demanded of a good or service in response to a change in income.
• What is Cross-Price Elasticity of Demand (XED)?

  A measure of the sensitivity of the quantity demanded of a product in response to a change in price of another product.
• What are the determinants of PED?

  • Time
  • Necessity/Luxury
  • Addictiveness of a product
  • Availability of substitutes
  • Percentage of income
• What is the significance of PED to firms?

  • Knowledge of PED is important to firms seeking to maximise their revenue.
  • If their product is price inelastic in demand, they should raise their prices.
  • If their product is price elastic in demand, then they should lower their prices.
• What is the significance of XED to firms?

  Firms need to be aware of their competition and those producing complementary goods. They need to know how price changes by other firms will impact them so they can take appropriate action.
• What is the significance of YED to firms?

  It is important for businesses to know how their sales will be affected by changes in the income of the population.

  • If the economy is improving and people's incomes are rising it is vital that a business knows whether this is likely to increase their sales or not.
  • It may have an impact on the type of goods that a firm produces. During times of prosperity, firms might produce more luxury goods and less inferior goods.
• What is the significance of PED to the Government?

  Knowledge of PED is also important to governments with regard to taxation and subsidies.

  • If they tax price inelastic in demand products, they can raise tax revenue without harming firms too much.
  • Consumers are less responsive to price changes so firms will pass on the tax to the consumer
  • If they subsidies price elastic in demand products, there can be a greater than proportional increase in demand.