1.2.3 Elasticities of Demand

• Factors that shift the demand curve (PIRATES)

  P = Population

  I = Income

  R = Related goods (substitutes or complements)

  A = Advertising

  T = Tastes and fashions

  E = Expectations

  S = Seasons
• Types of demand

  1. Derived demand
  2. Composite demand
  3. Joint demand
• Derived demand is when demand for one good is linked to the demand for another good.

  e.g., Demand for bricks and the demand for houses
• Composite demand is when the good demanded has more than one use.

  e.g., milk
• Joint demand is when goods are bought together

  e.g., camera and a memory card
• The demand curve is downward sloping, illustrating the inverse relationship between price and quality.
• The law of diminishing marginal utility states that as an extra unit of the good is consumed, the marginal utility falls and therefore consumers are willing to pay less for the good.
• Marginal utility is the benefit of consuming one more unit of a good or service.
• The price elasticity of demand is the responsiveness of a change in price to a change in quantity demanded.
• PED = % Change in QD / % Change in Price
• A price elastic good is very responsive to a change in price

  PED >1

  
• Price elastic good PED >1
• Price inelastic good has a demand that is unresponsive to change in price.

  PED <1

  
• Price inelastic goods PED <1
• Unitary elastic goods have a change in demand that is qual to the change in price.

  PED = 1

  
• Unitary goods PED = 1
• Perfectly inelastic goods have a demand which does not change with price.

  PED = 0

  
• Perfectly inelastic goods PED = 0
• Perfectly elastic goods have a demand which falls to zero when price changes.

  PED = infinity

  
• Perfectly inelastic goods PED = infinity
• Factors influencing PED (SPLAT)

  S = Substitutes

  P = Percentage of income spent

  L = Luxury of necessity

  A = Addictiveness or habit

  T = Time period (Durability or Season)
• If a firm sells a good with an inelastic demand, they will pass most of the tax burden to the consumer, because they know that a price increase will not cause demand to fall significantly.

  
• If a firm sells a good with an elastic demand, they will tale most of the tax burden themselves, because they know that if the price increase demand will fall.

  
• A subsidy is a payment from the government to firms to encourage the production of a good, increasing supply.
• The benefit of a subsidy can go to the producer n the form of increased revenue, or to the consumer, in the form of lower prices.

  
• Total Revenue = Price x Quantity
• Income elasticity of demand is the responsiveness of a change in demand to a change in income.
• Income Elasticity of Demand (YED) = % Change in QD / % Change in Y
• Inferior goods are those which see a fall in demand when income rises.

  YED = 0
• Inferior goods YED = 0
• Normal goods are goods where demand increases as income increases.

  YED = >0
• Normal Goods YED > 0
• Luxury goods are goods where an increase in income leads to a big increase in demand.

  (Normal Goods)
• Cross elasticity of demand is the responsiveness to a change in demand of one good (X) to a change in the price of another good (Y).
• Cross Elasticity of Demand (XED) = % Change in QD of X / % Change in P of Y
• Complementary goods have a negative XED, when. the price of one good increases, the quantity demanded for both decreases.
• unrelated goods have an XED of 0