1.2.3 Price Elasticity of Demand

Question 1

What is Elasticity of Demand?

Answer 1

Elasticity of demand is an attempt to measure the responsiveness of quantity demanded to
changes in other variables: its own price, the price of other goods and real income.

Question 2

How responsive is an elastic good?

Answer 2

Relatively responsive

Question 3

How responsive is an inelastic good?

Answer 3

Relatively unresponsive

Question 4

What is Price elasticity of demand (PED)?

Answer 4

This is the responsiveness of demand to a change in the price of the good

Question 5

What is the formula for PED?

Answer 5

% Change in Quantity demanded / % Change in Price

Question 6

Summarise Unitary elastic PED

Answer 6

Unitary elastic PED is where PED=1
- quantity demanded changes by exactly the same percentage as price.
- This would be shown as a reciprocal curve.

Question 7

Summarise Relatively elastic PED

Answer 7

Relatively elastic PED is where PED>1
- quantity demanded changes by a larger percentage than price so demand is relatively responsive to price.
- The curve will be more sloping

Question 8

Summarise Relatively inelastic PED

Answer 8

Relatively inelastic PED is where PED<1
- quantity demanded changes by a smaller percentage than price so demand is relatively unresponsive to price.
- The curve will be steep.

Question 9

Summarise perfectly elastic PED

Answer 9

Perfectly elastic PED is where PED=infinity
- a change in price means that quantity falls to 0 and demand is very responsive to price.
- This would be shown by a horizontal line

Question 10

Summarise perfectly inelastic PED

Answer 10

Perfectly inelastic PED is where PED=0
- a change in price has no effect on output so demand is completely unresponsive to price.
- This would be shown by a vertical line.

Question 11

What factors effect PED?

Answer 11

• Availability of Substitutes
• Time
• Necessity
• How large of a % of total expenditure
• Addictive

Question 12

Explain how availability of Substitutes effects PED?

Answer 12

• If a product has lots of substitutes (for example instead of buying Coke you could buy Pepsi), people will switch to other products when prices go up.
• Therefore, PED will be elastic. If there are no substitutes, then the demand curve will be inelastic since even if prices go up, people will have to buy that good if they want it as there are no alternatives.

Question 13

Explain how Time effects PED?

Answer 13

• The longer the time, the easier it will be for a person to find an alternative product/supplier of the product so the more elastic the good is.
• In the short term, many goods are inelastic as people may not even notice the price difference.

Question 14

Explain how Necessities effect PED?

Answer 14

If you need something, the demand curve will be inelastic because even if the price goes up, you still need to buy it.

Question 15

Explain How large of a % of total expenditure can effect PED

Answer 15

• If a good/service represents a very small percentage of a person’s expenditure, a significant increase in price will have a relatively small impact on how much they buy of that product so it will be inelastic e.g.
  matches.

Question 16

Explain how addiction effects PED?

Answer 16

If a product is addictive, then the demand curve will be inelastic. No matter how high prices are, people will still buy the good to fulfil their addiction.

Question 17

What is Income elasticity of demand (YED)?

Answer 17

This is the responsiveness of demand to a change in income.

Question 18

What does the gradient of an inelastic curve look like?

Answer 18

Steep Gradient

Question 19

What does the gradient of an elastic curve look like?

Answer 19

Shallow Gradient

Question 20

What is the formula for Income elasticity of demand (YED)

Answer 20

%change in quantity demanded / %change in income

Question 21

Name the Good when YED>0

Answer 21

Normal Goods

Question 22

Name the Good when YED<0

Answer 22

An Inferior Good

Question 23

Name the Good when YED>1

Answer 23

A Luxury Good

Question 24

Why is Income elasticity of demand (YED) significant?

Answer 24

• It is important for businesses to know how their sales will be affected by changes
  in the income of the population
• If the economy is improving and people’s incomes are rising it is vital that a business knows whether this is likely to increase their sales or not.
• It may have an impact on the type of goods that a firm produces
• During times of prosperity, firms might produce more luxury goods and less inferior goods.

Question 25

What is Cross elasticity of demand (XED)?

Answer 25

This is the responsiveness of demand for one product (x) to the change in price of another
product (y).

Question 26

Formula of Cross elasticity of demand (XED)

Answer 26

%change in quantity demanded of x / %change in price of y.

Question 27

Substitutes are where XED…..

Answer 27

XED>0

Question 28

Example of when Substitutes are where XED>0

Answer 28

• An increase in the price of good B will increase demand for good A.
• For example, Coca Cola and Pepsi are substitutes.

Question 29

Complementary goods are where…

Answer 29

XED<0

Question 30

Example of when complementary goods are where XED<0

Answer 30

• An increase in the price of good B will decrease demand for good A.
• One example is DVDs and DVD players

Question 31

Unrelated goods are where….

Answer 31

XED = 0

Question 32

What is the significance of XED?

Answer 32

• Firms need to be aware of their competition and those producing complementary goods.
• They need to know how price changes by other firms will impact them so they can take appropriate action.