Definitions
- Price elasticity of demand (PED) is a measure of the responsiveness of the quantity demanded for a good or service to change in its price.
- Inelastic demand is where a change in price of a good or service leads to a proportionately smaller change in the quantity demanded of the good or service. PED value is between zero and one.
- Elastic demand is where a change in price of a good or service leads to a proportionately larger change in the quantity demanded of the good or service. PED value is greater than one.
- Cross elasticity of demand (XED) is a measure of the responsiveness of the demand for one good or service to a change in price of another good or service.
- Substitute goods are goods that can be used against each other, such as sugar or honey. Substitute goods have a positive cross elasticity of demand.
- Complementary goods are goods which can be used together, such as MP3 players and headphones. Complementary goods have a negative cross elasticity of demand.
- Income elasticity of demand (YED) is a measure of the responsiveness of the demand for a good or service to a change in income.
- Normal goods have positive income elasticity of demand. As income rises, the demand for the good increases.
- Inferior goods have negative income elasticity of demand. As income rises, the demand for the good decreases.
- Price elasticity of supply (PES) is a measure of the responsiveness of the quantity supplied for a good or service to a change in its price.
- Inelastic supply is where a change in price of a good or service leads to a proportionately smaller change in the quantity supplied of the good or service. PES value is between zero and one.
- Elastic supply is where a change in price of a good or service leads to a proportionately larger change in the quantity supplied of the good or service. PES value is greater than one.
Price elasticity of demand (PED)
- Measure of how much quantity demanded of a product changes when there is a change in price of a product.
- PED = % change in quantity demanded of a product
% change in price of a product
- If PED = 0, change in price → No effect on quantity demanded → % change would be 0 → PED is perfectly inelastic.
- If PED = infinity, change in price → Demand will fall to 0.
- Normal goods have PED between 0 and 1.
- Demand for commodities tend to be inelastic since they are scarce resources.
- Demand for manufactured goods tend to elastic due to variety of choice presented to customers.
● Three categories of PED
❖ Inelastic demand
- Happens when PED is less than 1 and greater than 0.
- Change in price → Proportionally smaller change in quantity demanded → Total revenue gained by the firm increases when price increases.
❖ Elastic demand
- Happens when PED is less than infinity and greater than 1.
- Change in price → Proportionally larger change in quantity demanded → Total revenue gained by the firm decreases when price increases.
❖ Unit elastic demand
- Happens when PED = 1.
- Change in price → Proportionate, opposite change in quantity demanded → Total revenue gained by the firm stays the same when price increases.
● Determinants of PED
❖ Number and closeness of substitutes
- More substitutes for a product → More elastic the demand for the product will be.
- Products with fewer substitutes → Inelastic demand for the product.
❖ Necessity of the product and how widely the product is defined
- Necessity products such as food, clothes → Demand is inelastic.
- Products that are people’s wants → Demand is elastic.
❖ Time period considered
- PED is inelastic in the short term and becomes more elastic in the long term.
Cross elasticity of demand (XED)
- Measure of how much the demand of the product changes when there is a change in price of another product.
- XED = % change in quantity demanded of product X
% change in price of product Y
- If XED is positive, two goods, like wheat and rice, are substitute goods.
- If XED is negative, two goods, like iPod and earphones, are complementary goods.
- XED doesn’t change if two goods compared are unrelated to each other.
Income elasticity of demand (YED)
- Measure of how much the demand for a product changes when there is a change in consumer’s income.
- YED = % change in quantity demanded of the product
% change in customer’s income
- If YED is positive, it is a normal good.
- Low positive YED → Necessity good, such as food.
- High positive YED → Superior good, such as luxury products.
- If YED is negative, it is an inferior good.
Price elasticity of supply (PES)
- Measure of how much the supply of a product changes when there is a change in the price of the product.
- PES = % change in quantity supplied of a product
% change in price of the product
- Same effects as PED but in this case, it is the supply of a product being impacted, rather than the demand.
- Supply for commodities tend to be inelastic and manufactured goods tend to be elastic due to same reasons as mentioned in PED section.
● Determinants of PES
❖ How much costs rise as output is increased
- Rise in total costs → Producers doesn’t increase supply → PES is inelastic.
- Existence of unused stocks, mobility of factors of production prevents a huge rise in costs for products.
❖ Time period considered
- Same effects as PED, except the effects are on supply of the product, instead of demand of the product.
❖ Ability to store stock
- High levels of stock → Firms tend to react quickly to price changes → PES of the product is elastic.
Paper 3 Questions
The price of meat increases by 10%, the quantity demanded of meat falls by 12% and the quantity of fish consumed increases by 9%.
- Calculate the price elasticity of demand (PED) for meat and state if the demand for meat is price elastic or inelastic.
- Calculate the cross-price elasticity for demand between meat and fish, and state what kind of products meat and fish are to each other.
An individual’s income increased between $16,000 to $20,000. The spending on purchases of bread fell by 5% while the spending on purchases of food in general and eating out in restaurants increased by 15% and 30% respectively.
- Calculate the income elasticity for demand (YED) for each item and state the kind of item it is.
