1.2.3

• What is elasticity?


  Elasticity measures the responsiveness of one variable to the change in another variable.
• What is the formula for Price Elasticity of Demand (PED)?

  Price elasticity = % change in quantity demanded ÷ % change in price
• What are the different PEDs?

  Elastic demand is where the PED > 1.

  If a product is price elastic in demand:

  
  

  Decreasing price = increases total revenue.

  Increasing price = decreases total revenue.

  
  

  If demand is elastic, then producers should cut the price because this will raise total revenue.

  
  

  Inelastic demand is where the PED < 1.

  If a product is price inelastic in demand:

  
  

  Decreasing price = decreases total revenue.

  Increasing price = increases total revenue.

  
  

  If demand for a product is inelastic, a producer can increase price without the quantity sold falling very much.

  
  

  Unitary elasticity is where the PED = 1.

  
  

  PED is almost always negative as an increase in price would result in a decrease in demand.
• What is the formula for Income Elasticity of Demand (YED)?

  Income elasticity of demand = % change in quantity demanded ÷ % change in income.
• What are the different YEDs?

  Normal goods have a positive income elasticity, YED > 0 (income rises; demand increases).

  
  

  Inferior goods have negative income elasticity, YED < 0 (income rises; demand decreases)

  
  

  YED can be positive or negative
• What is Cross-Price Elasticity of Demand (XED)?

  Cross-Price elasticity of demand is when a change in the price of one good can change the quantity demanded of another.
• What is the formula for Cross-Price Elasticity of Demand?

  Cross-price elasticity of demand = % change in quantity demanded of good A ÷ % change in the price of good B.
• What are the different XEDs?

  XED is positive if the goods are substitutes and negative if the goods are complements. If XED is close to zero this would suggest that the goods are unrelated.
• How can the XED be described for complement goods?

  The cross-price elasticity of demand (XED) for complements is negative because a fall in the price of one good will increase the quantity demanded for the other good.

  
  

  For complements, a fall in the price of one good will lead to an increase in the quantity demanded for the other good. Complements have negative cross-price elasticities of demand.

  
  

  XED < 0
• How can the XED be described for substitute goods?

  For substitutes, a fall in the price of one will lead to a fall in the quantity demanded of the other. Substitutes have positive cross elasticities of demand.

  
  

  XED > 0
• How can the XED be described for independent goods?

  Independent goods have a cross-price elasticity of demand of zero.

  
  

  E.g. donkeys and ice cream

  
  

  XED = 0
• What is the PED of perfectly elastic demand?

  Perfectly elastic demand - PED = +/- infinity.

  
  

  What does this mean?

  
  

  Any price increase will cause demand to drop to zero.

  
• What is the PED of perfectly inelastic demand?

  Perfectly inelastic demand - PED = zero.

  
  

  What does this mean?

  
  

  Any price change won't affect demand.

  
• What happens when there is unitary elasticity?

  If there is unitary elasticity, any percentage change in price will be reflected in demand by an equivalent percentage change in quantity demanded.

  
• What is the formula for total revenue?

  Total revenue = price per unit × quantity.
• How does PED change along a straight demand curve?

  This is how price elasticity of demand (PED) changes along the demand curve:

  At zero demand or high price - minus infinity.

  
  

  At midpoint - elasticity is minus one.

  
  

  At zero price or high quantity - elasticity is zero.

  
  

  PED of +/- one = maximized total revenue. The closer a product's price is to the midpoint, the higher the revenue.