1.2.3: Price, income and cross elasticities of demand

• Price elasticity of demand: Responsiveness of quantity demanded to a change in price
• Formula for PED:

  % Change in quantity demanded / % change in price
• PED is always negative, because quantity demanded is inversely related to price
• Inelastic demand: Percentage change in quantity demanded is less than percentage change in price. PED value is between 0 and -1
• Elastic demand: Percentage change in quantity demanded is more than percentage change in price. PED value is greater than -1
• Unitary demand: PED = -1, percentage change in quantity demanded is the same as percentage change in price
• Perfectly elastic demand: PED = - infinity
• Perfectly inelastic demand: PED = 0
• When PED is elastic, increase in price leads to decrease in revenue
• When PED is inelastic, increase in price leads to increase in revenue
• When PED is unitary revenue will be unaffected by price change
• Factors influencing PED (STAIN)

  Substitutes increasing means higher PED

  Time

  Addiction

  % Income taken up

  Necessity
• Price elasticity of supply: Responsiveness of quantity supplied to a change in price
• Formula for PES: percentage change in Quantity supplied / Percentage change in price
• PES is positive as the quantity supplied and price are positively related
• Income elasticity of demand: Responsiveness of demand to a change in income
• If YED is negative for a good, it is an inferior good - Increase in income leads to decreased demand for it
• If a good has YED between 0 and 1, it is a normal good - Increase in income leads to increased demand for it
• If a good as YED > 1, it is a luxury good - Increase in income leads to even greater increase in demand for it
• Cross elasticity of demand: Responsiveness of demand for a good to a change in price of a related good
• Formula for Cross elasticity of demand: Percentage change in demand for good A / Percentage change in price of good B
• XED is positive for substitutes and negative for complements
• Substitutes: Goods that can be used in place of each other to satisfy a need
• Complements: Goods that are consumed together as they improve the value of each other
• XED between 0 and 1: Weak substitute
• XED > 0: Substitute
• XED < 0: Complement
• For substitutes, when price of good B increases, demand for good A increases
• For complements, when price of good B increases, demand for good A decreases