Price Elasticity of Demand
Elasticity looks at the responsiveness of one variable to a change in another
Price elasticity:
- The responsiveness of demand to a change in price
- %change in quantity demanded / % change in price
- If PED > 1 it is elastic (flat demand curve)
- If PED < 1 it is inelastic (steep demand curve)
These videos show an explanation of Price Elasticity of Demand.
Part 1 - What PED means and how we measure PED values.
Part 2 - How to improve your exam technique for Price Elasticity and Demand (PED)
Price Elasticity of Demand, Revenue and Profit
If a product is elastic to increase revenue you reduce price
The reduction in price increases quantity demanded by a greater amount therefore increasing revenue
If a product is inelastic to increase revenue you increase price
The increase in price reduces quantity demanded by a smaller amount therefore increasing revenue
If costs stay the same then these actions will result in greater levels of profit for the firm
Income Elasticity of Demand
Measures the responsiveness of demand to changes in income
- % change in quantity demanded / % change in income
- YED > 0 (positive sign) = Normal goods – as income rises demand rises
- YED < 0 (negative sign) = Inferior goods – as income rises demand falls
Cross Elasticity of Demand
Measures the responsiveness of demand of one good to changes in the price of another good
- % change in quantity of good 1 / % change in price of good 2
- Cross elasticity < 0 (negative sign) The goods are compliments
- Cross elasticity < 0 (positive sign) The goods are substitutes
Factors that Influence Elasticity of Demand
- Number of substitutes – the greater the number of substitutes the more elastic a product is
- The % of income spent on the product – the smaller the % the more inelastic the good
- The time period – the longer this is the more elastic the good is
- Luxury or necessity – Luxuries tend to be more elastic and necessities more inelastic
