Price, Income and Cross Elasticities of Demand

Question 1

What is the theory?

Answer 1

Elasticity theory looks at the sensitivity of one variable in relationship to another

Question 2

How do we work out percentage change?

Answer 2

Change/Original x 100

Question 3

What is an elasticity coefficient?

Answer 3

The measure of the response of one variable to changes in another variable e.g If price increases by 5% demand might decrease by 15%
-The elasticity coefficient is given by -15%/+5% = -3

Question 4

What does Price Elasticity of Demand (PED) measure?

Answer 4

The responsiveness of demand to a change in price

Question 5

How is PED calculated?

Answer 5

rice elasticity of demand = %age change in qd/%age change in price
qd= Quantity demand

Question 6

What does a perfectly inelastic product have a coefficient of?

Answer 6

0

Question 7

What happens to the quantity demanded if price changes, with a perfectly inelastic product?

Answer 7

If price was to change the quantity demanded would not be affected

Question 8

What coefficient does a price inelastic product have?

Answer 8

A price inelastic product will have a PED coefficient between 0 and -1

Question 9

What happens to demand if the price changes with a price inelastic product?

Answer 9

If price was to change the quantity demanded would change by a lesser amount

Question 10

What does a price elastic product have a coefficient of?

Answer 10

A price elastic product will have a PED coefficient between -1 and ∞

Question 11

What happens to demand if price changes with a price elastic product?

Answer 11

If price was to change the quantity demanded would change by a greater amount

Question 12

What does a perfectly elastic have a coefficient of?

Answer 12

A perfectly elastic product will have a PED coefficient of ∞

Question 13

What happens to quantity demanded when the price of a perfectly elastic product changes?

Answer 13

If price was to change the quantity demanded would be infinite

Question 14

What are changes in total expenditure influenced by?

Answer 14

PED

• If PED is elastic i.e. >1 a rise in price will cause total expenditure to fall and vice versa
• If PED is inelastic i.e. <1 a rise in price will cause total expenditure to rise and vice versa

Question 15

What is price elasticity determined by?

Answer 15

Substitutes- The number and closeness of available substitutes will help to determine PED
-If there are no close or lack of available substitutes the product is likely to be very price inelastic and vice versa

Question 16

What is the definition of a market?

Answer 16

As we widen the market so PED becomes more inelastic

• For example, cigarettes are very price inelastic as there are no close substitutes
• However, the demand for specific brands of cigarette will have a higher PED

Question 17

What is income elasticity of demand?

Answer 17

Income elasticity of demand (YED) is a measure of the responsiveness of demand to a change in income

Question 18

How do we work out income elasticity of demand?

Answer 18

Income elasticity of demand = %age change in qd/%age change in income

Question 19

What is YED determined by?

Answer 19

Whether the good is a necessity or a luxury
-At higher standards of living increased consumer incomes see additional demand tend towards luxury goods as demand for necessities is satiated

Question 20

Are wealthier countries likely to have higher or lower standards of living?

Answer 20

Higher

Question 21

What is cross-elasticity of demand?

Answer 21

Cross-elasticity of demand (XED) is a measure of the responsiveness of demand for one good x to a change in price of nother good y.

Question 22

How so we work out XED?

Answer 22

Cross elasticity of demand = %age change in quantity of A/%age change in price of B

Question 23

What is XED determined by?

Answer 23

Whether the product is a: Substitute

• Substitutes will have a positive cross-elasticity of demand
• As the price of good Y increases (positive) the demand for good X will increase (positive)
• Close substitutes will have a higher XED as consumer demand for good X will be more sensitive to a change in price of good Y

Question 24

What is a complement?

Answer 24

• Complements will have a negative cross-elasticity of demand
• As the price of good Y increases (positive) the demand for good X will decrease (negative)
• Close complements will have a higher XED as consumer demand for good X will be more sensitive to a change in price of good Y

Question 25

What will firms do?

Answer 25

Attempt to change the cross-elasticity of their products

Question 26

How will firms attempt to change XED?

Answer 26

Substitutes Firms will try to differentiate their products from the competition Complements Firms will produce a range of complements to accompany their core products

Question 27

What factors determine PED?

Answer 27

``` Substitutability Percentage of income Type of good The width of the market definition Time ```

Question 28

What is Substitutability?

Answer 28

The most important determinant of PED. -When a substitute exists for a product consumers, respond to a price rise by switching spending away from the good and buying a substitute whose price has not risen

Question 29

What is Percentage of Income?

Answer 29

The demand for goods or services on which households spend a large proportion of their income tend to be more elastic than those small items that account for only a small fraction of income

Question 30

What are necessities or luxuries?

Answer 30

It is sometimes said that demand for necessities are price inelastic whereas luxury goods are elastic. However if no substitute exists then demand for a luxury good may be inelastic and if there are available substitutes for necessities then they would be elastic

Question 31

What is the width of the market?

Answer 31

The lower the PED. The demand for bread produced by a certain baker is likely to be more elastic than the demand for bread produced by all bakers. Other bakeries are providing a number of close substitutes. This can be stretched further

Question 32

What is time?

Answer 32

For many goods and service demand is more elastic in the LR than the SR because it takes time to respond to a price change

Question 33

What are the rules of PED elasticity?

Answer 33

- If total consumer spending increases in response to a price fall, demand is elastic - If total consumer spending decreases in response to a price fall, demand is inelastic - If consumer spending remains constant to a price fall then it is neither elastic or inelastic - unit elastic