1.2.3: Price, income and cross elasticities of demand

• PED: Responsiveness of demand to a change in price of a good
• Formula for PED: %change in quantity demanded / %change in price
• Unitary Elastic: PED = 1

  Relatively Elastic: PED > 1

  Relatively Inelastic: PED < 1

  Perfectly Elastic: PED = Infinity

  Perfectly Inelastic: PED = 0
• Factors affecting PED:

  Availability of substitutes: More substitutes means higher PED

  Time: In the long term people can find more alternatives, increasing PED

  Necessity: Necessary goods are more inelastic

  % of total spending: If a good takes up more of your income it will be more elastic

  Addictive: If a product is addictive it will be inelastic
• PED and PES determine the effects of imposing indirect taxes and subsidies
• If a demand curve is more elastic, there is less incidence of tax on consumers and more on producers
• An elastic demand curve has a steeper gradient
• Subsidies cause a small fall in price for consumers, but a large amount of revenue for producers
• For an elastic demand curve: Decrease in price leads to increase in revenue and vice versa
• For an inelastic demand curve: A decrease in price leads to a decrease in revenue and vice versa
• For a unitary elastic curve, a change in price has no effect on revenue
• Income elasticity of demand: The responsiveness of demand to a change in income
• Formula of Income elasticity of demand (YED): % change in Quantity demanded / %change in income
• Inferior good: When YED < 0: Increased income leads to decrease in demand
• Normal good: When YED >= 0: Increased income leads to increased demand
• Luxury good: When YED > 1: Increased income leads to even greater increase in demand
• Income elasticity of demand is important as it shows businesses how their sales will be affected by changes in income in the population. For example when average income is high, firms may produce more luxury goods
• Cross Elasticity of Demand: Responsiveness of demand of one product to a change in price of another
• Formula for Cross Elasticity of Demand (XED): % change in Quantity Demanded of good 1 / % change in price of good 2
• Substitutes are where XED > 0: Increase in price of Good 1 will increase demand for good 2 e.g coca cola and pepsi
• Complements are where XED < 0: Increase in price of good 1 will decrease demand for good 2 e.g consoles and console games
• Unrelated goods are where XED = 0: Change in price of good 1 has no impact on good 2
• The size of XED represents the strength of the relationship between the two goods.
• Cross elasticity of demand is important as it helps firms be aware of how changes to their competition affects them