Revision:Elasticity of Demand

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Elasticity of demand is the responsiveness of a good to changes in price, income and the demand for substitutes and complements.

Price elasticity of demand

Price elasticity of demand (PED) is measurement of how demand for a good responds to a change in price.

The value of PED will always be negative because when price increases the quantity demanded falls (for the same reason the demand curve slopes downwards). The signs here are irrelevant; what is important is the magnitude.

Goods with unit elasticity experience an equally proportionate change in price to a change in quantity. For elastic goods, a proportionate change in price leads to a greater than proportionate change in quantity. For inelastic goods, a proportionate change in price leads to a less than proportionate change in quantity.

• A PED of -1 has unit elasticity
• A PED between 0 and -1 is inelastic
• A PED which is less than -1 (i.e. a "bigger" negative number, such as -2) is elastic

Worked example

When the price of cinema tickets falls from £8 to £6, the quantity demanded increases from 20 to 25 units. What is the PED of cinema tickets?

• Proportionate change in quantity is
• Proportionate change in price is
• Therefore
• This shows the PED for cinema tickets is somewhat inelastic.

Showing PED graphically

PED affects the gradient of demand curves.

• The demand curve for inelastic goods has a steep gradient. Perfectly inelastic goods have vertical demand curves (looks like a capital I)
• The demand curve for elastic goods has a gentle gradient. Perfectly elastic goods have horizontal demand curves (looks a bit like a capital E)

The elasticity of demand falls over the length of any given straight-line demand curve. At low quantities, a fall in price has a large response (i.e. elastic). At high quantities, the market is almost saturated and a fall in price has little response (i.e. inelastic).

Factors influencing PED

1. Availability of substitutes
2. Luxury or necessity good
3. Bought at short intervals or long intervals
4. Willingness of consumer to try new brands (habit forming goods)
5. Incomes
6. Importance in consumption patterns
7. Market information, transport and communication

Income elasticity of demand

Income elasticity of demand (YED) is a measurement of how a good responds to a change in income.

Unlike for PED, for YED the signs are significant:

• A negative YED indicates an inferior good (goods which are demanded less when income rises e.g. builders' tea, tabloid newspapers, cigarettes)
• A YED of 0 indicates a necessity good (goods which are not demanded more or less when income changes e.g. salt)
• A positive YED between 0 and 1 indicates a normal good (goods which are demanded more when income rises e.g. DVDs, cushions)
• A positive YED, greater than 1, indicates a superior good (good which are demanded proportionally more when income rises e.g. foreign holidays)

Cross elasticity of demand

Cross elasticity of demand (XED) is the responsiveness of a good to a change in the price of a substitute or a complement.

• Complements (e.g. fish and chips) have a negative XED
• Unrelated goods have a XED of 0.
• Substitutes (e.g. margarine and butter) have a positive XED.

Also See

Take a look at the other unit 1 A level economics revision notes:

• The Economic Problem (AQA, Edex, OCR, WJEC)
• Factors of production (AQA, OCR)
• Positive and normative economics (AQA)
• Specialisation and Trade (AQA, Edex, OCR, WJEC)
• Producer and consumer surplus (AQA, Edex, OCR, WJEC)
• Demand theory (AQA, Edex, OCR, WJEC)
• Supply theory (AQA, Edex, OCR, WJEC)
• Supply and Demand Equilibrium (AQA, Edex, OCR, WJEC)
• Elasticity of demand (AQA, Edex, OCR, WJEC)
• Elasticity of supply (AQA, Edex, OCR, WJEC)
• The Price Mechanism (AQA, Edex)
• Indirect Taxes and Subsidies (Edex)
• The labour market (Edex)
• Economies of scale (AQA)
• Allocative efficiency (OCR)

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