Unit 2.2 - Elasticity of demand (PED, YED and XED)

• PED


  Price elasticity of demand

  
• YED


  Income elasticity of demand

  
• XED


  Cross elasticity of demand

  
• Unit 2.2 Elasticity


  • Definition of price elasticity, income elasticity and cross elasticity of demand (PED, YED, XED)
  • Formulae for and calculation of price elasticity, income elasticity and cross elasticity of demand
  • Significance of relative percentage changes, the size and sign of the coefficient of: price elasticity of demand, income elasticity of demand, cross elasticity of demand
  • Descriptions of elasticity values: perfectly elastic, (highly) elastic, unitary elasticity, (highly) inelastic, perfectly inelastic
  • Analyse variation in price elasticity of demand along the length of a straight-line demand curve
  • Evaluate factors affecting: price elasticity of demand, income elasticity of demand, cross elasticity of demand
  • Evaluate the relationship between price elasticity of demand and total expenditure on a product
  • Analyse the implications for decision-making of price elasticity, income elasticity and cross elasticity of demand

  
• Elasticity


  An economic concept used to measure the change in the aggregate quantity demanded of a good or service in relation to price movements of that good or service. Its responsiveness to changes in another variable.

  
• Elastic product


  A product is considered to be elastic if the quantity demand of the product changes more than proportionally when its price increases or decreases.

  
• Effect of price changes on demand

  1. Calculate the percentage change in quantity demanded

  2. Calculate the percentage change in price

  3. Divide the percentage change in quantity by the percentage change in price

  4. Remove the minus sign. PED is the absolute form of the calculation

  
• The demand is (in)elastic, not the product.
• PED range


  • Perfectly inelastic: 0
  • Inelastic: <1
  • Unit elastic: (-)1
  • Elastic: >1
  • Perfectly elastic: ∞

  
• Factors affecting PED


  • Availability & attractiveness of substitutes
  • The relative expense of the product
  • Time period (short and long run)
• When prices are high


  Quantity demand is low
• A change in price

  Will be small but produce a greater change in quantity demanded and same for the inverse

  
• Income elasticity of demand (YED)

  The sensitivity to changes in consumer income relative to the amount of a good that consumers demand.

  
• YED based on size and sign

  • Normal goods: Quantity demanded increases as income increases, YED is + and between 0 - 1 usually
  • Inferior goods: Quantity decreases as income increases, YED is - and size indicates relationship

  
• Normal goods


  • Necessity goods: Quantity demanded does not change as income increases, YED is + and close to 0
  • Superior/luxury goods: Quantity demanded is responsive to changes in income, YED is + and greater than 1

  
• Cross elasticity of demand (XED)

  The way that changes in the price of one good can affect the quantity demanded of another good.

  
• XED based on size and sign

  • Cross elastic: Greater percentage change in quantity demand for a good than the change in the price of another good, XED is greater than 1 (>1)
  • Cross inelastic: Lesser percentage change in quantity demand for a good than the change in the price of another good, XED is less than 1 (<1)
  • Substitute goods will have a positive cross-elasticity of demand (+)
  • Complements will have a negative cross elasticity of demand (-)
  • Unrelated goods will have a cross-elasticity of demand of zero

  
• How PED, YED and XED affect decision making

  • PED can be used to explain: Price variations in the market, Impact of changing prices on consumer expenditure and sales revenue, Effect on changes in indirect tax on government revenue
  • YED provides information on how quantity demanded changes with changes to income. Government and firms can use this to forecast demand. During a recession, demand for inferior goods will increase and demand for normal goods will decline.
  • XED helps firms understand the effect of competitors pricing strategies on the demand for their goods. Firms will use pricing structures to increase joint demand - to increase the sale of complementary products