1.2.3 Price, income and cross elasticities of demand

• Normal goods:

  Goods for which an increase in income would lead to an increase in demand, e.g. designer goods.
• Inferior goods:

  Goods for which an increase in income would lead to a decrease in demand, e.g. public transport.
• Substitute goods:

  Goods that are alternative options for consumers, e.g. Coke and Pepsi.

  An increase in the price of good A would increase demand for good B.
• Complementary goods:

  Goods that are often consumed together, e.g. tea and milk.

  An increase in the price of good A would decrease demand for good B.
• Price elasticity of demand (PED):

  The responsiveness of quantity demanded to changes in price.

  PED = %∆Qd / %∆P

  PED will always be a negative number.
• Interpreting PED numbers

  Greater than 1 = Elastic

  Between 0 and 1 = Inelastic

  1 = Unitary

  Infinite ∞ = Perfectly elastic

  0 = Perfectly inelastic
• Price elastic demand

  If demand is price elastic, then a % change in price leads to a greater % change in quantity demanded.

  
• Price inelastic demand

  If demand is price inelastic, then a % change in price leads to a smaller % change in quantity demanded.

  
• Determinants of PED

  S (availability of substitutes)

  P (proportion of income)

  L (luxury or necessity)

  A (addictive or not)

  T (time to respond)
• Income elasticity of demand (YED):

  The responsiveness of quantity demanded to changes in income.

  YED = %∆Qd / %∆Y
• Interpreting YED numbers

  Less than 1 = Inferior good e.g. public transport

  Between 0 and 1 = Normal good with income inelastic demand (necessity) e.g. staple foods

  More than 1 = Normal good with income elastic demand (luxury) e.g. holidays
• +ve YED meaning

  Normal goods have a +ve YED; when income rises, demand rises and vice versa.
• -ve YED meaning

  Inferior goods have a -ve YED; when income rises, demand falls and vice versa.
• Cross elasticity of demand (XED):

  The responsiveness of quantity demanded of one good to changes in price of another good.

  XED = %∆Qd of good A / %∆P of good B
• Interpreting XED numbers

  Negative = Complements e.g. PS5 console & PS5 games

  0 = Unrelated goods

  Positive = Substitutes e.g. Coke and Pepsi