Yukihiro Murakami
Economics – Elasticity
SL/HL Core – Assessment Objectives
Sub-topic
Price Elasticity of Demand (PED)
Price Elasticity of Demand and its
determinants
AO2 - Explain the concept of price elasticity of demand,
understanding that it involves responsiveness of quantity demanded
to a change in price, along a given demand curve.
PED is a measure of how much the quantity demanded of a product
changes when there is a change in the price of the product.
AO4 - Calculate PED using the following equation.
Percentage change in quantity demanded
PED =
Percentage change in price
Percentage change =
b-a
*100
a
b-a
*100)
PED = a
b-a
(
*100)
a
(
AO1 - State that the PED value is treated as if it were positive
although its mathematical value is usually negative.
The negative value indicates that there is an inverse
relationship between price and the quantity demanded, but
to simplify matters, the negative signs are usually
ignored.
AO2 - Explain, using diagrams and PED values, the concepts of
price elastic demand, price inelastic demand, unit elastic demand,
perfectly elastic demand and perfectly inelastic demand.
Perfectly inelastic demand: When a price change does not alter the
quantity demanded.
Price inelastic demand: When a price change alters the quantity
demanded by a fewer amount than the proportionate amount.
Unit elastic demand: When a price change alters the quantity
demanded by a proportionate amount.
Price elastic demand: When a price change alters the quantity
demanded by a greater amount than the proportionate amount.
Perfectly elastic demand: When a minimal price change changes the
quantity demanded to 0.
AO2 - Explain the determinants of PED, including the number and
closeness of substitutes, the degree of necessity, time and the
proportion of income spent on the good.
The number and closeness of substitutes: If close multiple substitutes
are present, the demand for the product is elastic.
The necessity of the product: If the product is considered a necessity
good, its demand for the products is usually inelastic.
The time period: In the short term, demand for a product may be
inelastic while in the long term, demand for a product may be more
elastic.
AO4 - Calculate PED between two designated points on a demand
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curve using the PED equation above.
AO2 - Explain why PED varies along a straight line demand curve
and is not represented by the slope of the demand curve.
Applications of price elasticity of
demand
When a line is steep, its slope may be about 5. When a line is steep
when measuring the PED, it is considered inelastic, and is between 1
and 0. They are different.
AO3 - Examine the role of PED for firms in making decisions
regarding price changes and their effect on total revenue.
Firms should increase price on products with inelastic demand so that a
price change would only decrease consumers minimally.
AO2 - Explain why the PED for many primary commodities is
relatively low and the PED for manufactured products is relatively
high.
The PED for many primary commodities is relatively low because they
are necessities for consumers and they have few or no substitutes.
The PED for manufactured products is relatively high because there are
more substitutes available for customers.
AO3 - Examine the significance of PED for government in relation
to indirect taxes.
Governments should consider PED values when imposing indirect taxes
so that firms don't go out of business. Imposing an indirect tax on
products with inelastic demand would be the wise choice as most of the
tax burdens then would be on the consumers.
Cross price elasticity of demand
(XED)
Cross price elasticity of demand and its
determinants
AO1 - Outline the concept of cross price elasticity of demand,
understanding that it involves responsiveness of demand for one
good (and hence a shifting demand curve) to a change in the price of
another good.
XED is the measure of how much the demand for a product changes
when there is a change in the price of another product.
AO4 - Calculate XED using the following equation.
Percentage change in quantity demanded of good x
XED =
Percentage change in price of good y
Percentage change =
b-a
*100
a
b-a
*100)
XED = a
b-a
(
*100)
a
(
AO4 - Show that substitute goods have a positive value of XED and
complementary goods have a negative value of XED.
Substitute goods have a positive value of XED because when the price
of product x falls, demand for product x will increase, and demand for
product y would decrease. There is a decrease in quantity demanded for
product y, and a decrease in price of product x and thus, a positive value
of XED indicates a substitute good.
When the price of good a falls, the demand for good a would increase,
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and its complement good b would also increase in demand. Increase in
good b divided by decrease in the price of good gives a negative XED
value, showing that good b is a complement to good a.
AO2 - Explain that the (absolute) value of XED depends on the
closeness of the relationship between two goods.
Assuming Xboxs and PS3s are close substitute goods.
Applications of cross price elasticity of
demand
Absolute value of XED depends on the closeness of the relationship
between two goods because if the price of Xbox rises a bit, everyone
would switch over to the PS3 and the sales of PS3 may skyrocket. Thus
if a small change in price increases/decrease the sales of another product
by a significant amount, the absolute value of XED would be high.
AO3 - Examine the implications of XED for businesses if prices of
substitutes or complements change.
If prices of substitutes from firm B increases/decreases, firm A should
increase/decrease the number of products they produce so that excess
demand or excess supply can be evaded.
If prices of complements from firm B increases/decreases, firm A
should decrease/increase the number of products they produce.
Income elasticity of demand (YED)
Income elasticity of demand and its
determinants
AO1 - Outline the concept of income elasticity of demand,
understanding that it involves responsiveness of demand (and hence
a shifting demand curve) to a change in income.
YED is the measure of responsiveness of how much the demand for a
product changes when there is a change in the consumer’s income.
AO4 - Calculate YED using the following equation.
Percentage change in quantity demanded
YED =
Percentage change in income
b-a
Percentage change =
*100
a
b-a
(
*100)
YED = a
b-a
(
*100)
a
AO4 - Show that normal goods have a positive value of YED and
inferior goods have a negative value of YED
Normal goods have a positive value of YED because when a
consumers’ income increases/decreases, the normal good consumption
should increase/decrease, thus creating a positive YED value.
Inferior goods have a negative value of YED because when a
consumer’s income increases/decreases, the inferior good consumption
decreases/increases, thus creating a negative YED value.
AO2 - Distinguish, with reference to YED, between necessity
(income inelastic) goods and luxury (income elastic) goods.
Applications of income elasticity of
Necessity goods refer to products that a consumer needs whether they
have an increased income or a decreased income. The quantity
demanded for this type of product should not change dramatically when
there is increase/decrease in consumer income. On the contrary, luxury
goods can be bought if and only if there is increase in consumer income.
AO3 - Examine the implications for producers and for the economy
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demand
Price elasticity of Supply (PES)
Price elasticity of supply and its
determinants
of a relatively low YED for primary products, a relatively higher
YED for manufactured products and an even higher YED for
services.
AO2 - Explain the concept of price elasticity of supply,
understanding that it involves responsiveness of quantity supplied
to a change in price along a given supply curve.
PES is a measure of responsiveness of how much the supply of a
product changes when there is a change in the price of the product.
AO4 - Calculate PED using the following equation.
Percentage change in quantity supplied
Percentage change in price
b-a
Percentage change =
*100
a
b-a
(
*100)
PES = a
b-a
(
*100)
a
PES =
AO2 - Explain, using diagrams and PES values, the concepts of
elastic supply, inelastic supply, unit elastic supply, perfectly elastic
supply and perfectly inelastic supply.
Perfectly inelastic supply: When a change in price has no effect on the
quantity supplied.
Inelastic supply: When a change in price leads to a less than
proportionate change in supply.
Unit elastic supply: When a change in the price of the product leads to
a proportionate change in the quantity supplied.
Elastic supply: When a change in price leads to a greater than
proportionate change in the quantity supplied.
Perfectly elastic supply: When a change in price causes the quantity
supplied to fall to 0.
AO2 - Explain the determinants of PES, including time, mobility of
factors of production, unused capacity and ability to store stocks.
In the short run, the value of PES should be inelastic and in the long run,
it becomes much more elastic.
If factors of production are easily moved from one productive use to
another then PES will be relatively elastic.
If a firm has a lot of unused capacity, they will be able to increase
output with ease and thus the elasticity of supply is relatively high.
If a firm is able to store high levels of stock of their product, the PES
would be relatively elastic.
Applications of price elasticity of
supply
AO2 - Explain why the PES for primary commodities is relatively
low and the PES for manufactured products is relatively high.
The PES for primary commodities is relatively low because a change in
price cannot lead to a proportionately large increase in quantity
supplied.
The PES for manufactured products is relatively high because it is easier
to increase or decrease quantity supplied in response to a change in
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price.
PED
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PES
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XED
If Goods A and B are substitute goods for each other, and if the price of Good A
rises,
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If Goods A and C are complement goods, and if the price of good A rises,
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YED: The Engel curve