Price, income and cross elasticities of demand

• PED


  Responsiveness of a change in demand to a change in price.
• PED


  % change in Qd / % change in P
• Elastic


  Very responsive to a change in price; coefficient >1
• Inelastic


  Relatively unresponsive to a change in price; coefficient <1
• Unitary elasticity


  Change in demand = Change in price; PED=1
• Perfectly inelastic


  Demand does not change when price changes; PED=0
• Perfectly elastic


  Demand which falls to 0 when price changes; PED=∞
• Ignore - or + when calculating PED.
• Factors influencing PED:

  • Type of good, i.e. necessity or luxury, complementary or substitute.
  • Long-run, short-run
  • Addiction / habit
  • Proportion of income spent on the good
  • Peak / off-peak
• Taxes and subsidies shift the supply curve, not demand curve.
• The burden of an indirect tax will fall differently on consumers and firms, depending on the good's elasticity of demand.
• Firm sells inelastic good


  Will put tax burden on consumer because a price increase won't decrease demand by much; consumers will still buy the good and therefore cover the tax too.

  This method is the most effective to raise government revenue.
• Firm sells elastic good


  Put tax burden on themselves because a price increase to include tax will decrease demand significantly and therefore lower the firm's overall revenue.

  • Not as effective for raising government revenue, but effective if the government wants to reduce the demand of a particular good (because this will increase their production costs so they will decrease their production and supply of goods)
• Subsidy


  Payment from the government to firms to encourage the production of a good and to lower their average costs.
• A subsidy has the opposite effect of a tax.
• PED inelastic 


  £ increase = TR increase
• PED elastic


  £ increase = TR decrease
• YED


  Responsiveness of a change in demand to a change in income.
• YED


  % change in Qd / % change in Y
• YED


  Inferior goods: Demand decreases as Income increases; YED>0 but <1
• YED


  Luxury goods: Demand increases as Income increases; YED>1
• During periods of prosperity, such as economic growth when real incomes are rising, firms might switch to producing more luxury goods and fewer inferior goods, because demand for luxury goods will be increasing .
• XED


  Responsiveness of a change in demand of one good to a change in price of another good.
• XED


  % change in Gd of X / % change in P of Y
• -XED


  Complementary goods: as £ increases, demand for both goods decreases.
• +XED


  Substitutes (demand curve is upward sloping).
• XED = 0


  Unrelated goods
• Firms are interested in XED because it allows them to see how many competitors they have.