• Elasticity of demand refers to the responsiveness of quantity demanded to a change in some other factor

• Price Elasticity of Demand refers to the responsiveness of quantity demanded to a change in price

• PED = % change in demand / % change in price

• Types of Price elasticity:

  1. Perfectly Inelastic: PED = 0; change in price will have no effect at all; unresponsive
  2. Perfectly elastic: PED = infinity; change in price; infinite change in quantity demanded.
  3. Inelastic Demand: PED < 1 , less than proportionate
  4. Elastic demand: PED > 1; more than proportionate
  5. Unit elasticity : PED = 1, less than proportionate

  Use revenue boxes diagrams:

  

Elastic demand. Revenue box c is lost and a is gained when price is increased. Revenue is lost

Inelastic demand. revenue box c is lost revenue box a is when price was increased. revenue increases.

• Factors affecting PED:

  • Time Period
  • Habits
  • Income % spent on the product
  • Substitutes

• This can be summarized as THIS

• Why is the knowledge of PED important?

  

• Income Elasticity of Demand measures the responsiveness of quantity demanded to a change in Income.

• YED = % change is quantity demanded / % change in income

• Through YED we can determine the nature of a product (inferior, necessity or luxury)

• YED < 0 suggests that the good is inferior

• 0 < YED < 1 suggests that the good is a necessity/ normal good

• YED > 1 suggests that the good is a luxury

• Refer to Engel Curve (Curve between qty demanded and income)

  

  Cross Elasticity of Demand XED:

  Responsiveness of Qty Demanded of Good A to a change in price of Good B

  Formula: %change in qty (A)/ %change in price (B)

  Significance of signs with respect to complements and substitutes

  • If the goods are complements, the value will be negative • Complementary goods: • Quantity demanded increases when the price of the complement falls • If the price of gas fell to 10 cents a litre, sales of cars would increase

  • A positive value signifies that the two goods are substitutes • Substitute goods: • Quantity demanded of one good falls when the price of the substitute falls • If the price of coffee rises, people tend to consume less coffee and more tea