Section A2: Construct Summary Table for Elasticity Concepts
Price elasticity of demand
PED measures the responsiveness
of quantity demanded of a good to
changes in its own price, ceteris
paribus.
Income elasticity of demand
YED measures the responsiveness of
demand of a good to changes in income,
ceteris paribus
Cross elasticity of demand
CED measures the responsiveness of
demand of a good X to changes in
price of good Y, ceteris paribus
% change in Qd
% change in price
% change in Qd
% change in income
% change in QdX
% change in price of good Y
Sign
Always negative due to the law of
demand - price and Qd are inversely
related
Can be positive or negative depending the
kind of goods - normal (YED > 0 - DD↑
when Y↑)
or inferior (YED < 0 - DD↓ when Y↑)
Can be positive (CED>0 - DDx↑, when
Py↑) negative (CED<0 – DDx↓ when
Py ↑) and zero (DDx unchanged when
Py changes)
Magnitude/
Determinants
xplain
with
good examples
PED > 1
Qd
changes
more
than
proportionate than price
E.g Soft drinks as there are many
substitutes (beverages) available.
Luxury goods such as abalone
compared to rice will have a more
price-elastic demand (nature of
good).
YED < 0
Inferior goods such as canteen food vs
restaurant food
CED = 0
Unrelated goods
Changes in price of vegetables will not
affect cars
PED <1
Qd changes less than
proportionate than price
E.g Demand for cigarettes is priceinelastic due to its addictive nature.
Demand for matches is also priceinelastic due to a low proportion of
income spent on the good.
0 <YED<1
Necessities - the more basic a good is, the
lower the YED - bread and potatoes. Also
the rate at which the desire of a good is
satisfied as consumption increases for
example food. One need not consume too
much food before feeling satisfied thus as
income increases there is a less than
proportionate increase in consumption of
food. However, this will also depend of the
level of income of the consumers. The poor
will be more responsive to a change in
income resulting in a more than
proportionate change in consumption of
food.
CED>0
Substitutes - for example, McDonald
and Burger King, a decrease in the
price of McDonald will lead to a fall in
the demand for Burger King and viceversa.
YED >1
Luxury goods such as jewellery, art work
and cars.
CED<0
Complements - for example, pastries
and beverages, a fall in the price of
latter will lead to the rise in demand for
donut.
Definition
Formula
However, when prices rise, people
take time to adjust and find
alternatives hence the longer the
time period after a price change,
the more price elastic will be the
demand for the good.
The closer one good is a substitute of a
complement of another, the bigger the
effect on quantity of the first good as
the result of a change in the price of a
substitute or complement. Hence, the
greater the cross elasticity of demand.
Application/
Strategy
(Usually
not
included in part
(a) of an essay
when they ask
for explanation
on
these
concepts
–
more for part
(b)
on
application esp.
for strategizing)
Lower price when demand is price
elastic and increase price when
demand is price inelastic
Identify goods which are normal / incomeelastic / income-inelastic & set output
accordingly as income levels change.
Recession – demand for inferior goods will
rise so raise production of low-end/no frills
products such as budget airlines
Boom – demand for normal goods will rise
esp. luxury goods so introduce high end
goods such as 3G handphones; locate
shops at prime area
Follow suit when market leader/min
rivals lower price
For substitutes: A firm can try to
differentiate its services to reduce the
positive cross elasticity e.g. for a travel
agency, to offer a free ticket to travel in
Asia with any travel package to Europe
or organise tours to more exotic places
etc.
With close complements, the firm may
consider joint promotions or joint
discounts. Eg a firm offering slimming
packages may organize a joint
promotion with a beauty salon or
hairdresser.