Price Elasticity

What is price elasticity?

Defintion: This is the responsiveness of the quantity demanded or supplied by consumers or producers to a given change in price. 

This is given by the formula:

PED=%Change Quantity%Change Price

Calculating % Change

You can do this by using the formula below:

%P = P2-P1P1 or P2P1-1

Types of price elasticity

  1. Price elasticity of demand
  2. Cross elasticity of demand
  3. Income elasticity of demand
  4. Price elasticity of supply.

Price elasticity of demand

Acronym: PED

Defintion: This is how responsive the quantity demanded by consumers is to a change in price

Formula

PED=%Change Quantity demanded%Change Price=Q2-Q1Q1P2-P1P1

Range of values of PED and singificance

Value What it means Terminolgy Example
PED>1 % change in Quantity demanded is more than % change in price. Price elastic demand High priced luxury goods such as phones.
0<PED<1 % Change in Quantity demanded is less than % change in price Price inelastic demand Low priced products such as commodities. E.g corn.
PED = 1 % change quantity is same as % change price. This occurs on an exponential demand curve.  Unitary elastic demand   
PED = 0 The quantity demanded does not care about the price. It does not change. Graph is perfectly inelastic (looks like an I as in inelastic). Perfectly inelastic Demerit goods. Cigarettes.
PED = Infinite   Perfectly Elastic  

Commodities have very inelastic demand because they are inputs into manufacturing and thus have derived demand. They also have very few substitutes (E.g coffee beans have no substitutes)

Determinants of PED

Determinant Effect Reason Examples
Number of subsitute goods and closeness. More subsititues = Higher elasticity Lots of similar goods means consumers can easily change product.  Coke and pepsi are elastic. 
How well defined it is. 

More defined = Higher elasticity

The more defined a product the more subsitutes there are. 

Beef has subsitutes like fish, lamb, chicken. But meat has very few subsitutes. 
How neccessary a good is

More neccessary = Lower elasticity

If you really want a good you are less likely to care about changes in price.

Addicitive substances or crucial medicine like a cancer drug. 
Time period considered Shorter time perioid = Lower elasticity If takes time to change your lifestyle to incorporate subitute of a good if the goods price changes. If you use coal to heat your house and price increases that winter you may stick with it but by the next year you will probably have brought a heater.

Splat (Number of subsidies, proportion of income, luxury or commodity, addiction, time period)

Cross elasticity of demand

Acronym: XED

DefinitionThis is how responsive the quantity demanded by consumers of product a is to a change in price of product B

This allows to figure out how much the price of one good is able to affect how much consumers want to by another good. This value is a good indicator of how good of a subsitute they are. 

Formula

 

XED=% change Quantity demanded of product A%Change Price of product B

Range of values of XED and singificance

In the case of XED the sign before the value + or - is important. It tells you whether an increase in price will make the other products price go up or down. 

This can let you know if two products are complents or subsitutes, because a price decrease in a product would make it's complementary product's demand go up while it's competitions demand go down. It is logical. 

Value What it means Type of good Example
High positive A small % increase in price of one good while make the subsitutes good demand increase alot. Close subsitutes Competitive brands such as Coke and Pepsi
Low positive A small % increase in price of one good while make the subsitutes good demand increase a little Rmeote subsitutes Not so competive goods like burger king and pizza hut. 
XED = 0 Any change in price of one good seems to have no effect on the other goods quantity demanded Unrelated goods Any two unrelated goods. Beef and education. 
XED is negative An % increase in price of one good decreases the quantity demanded of the other good. They are likely goods sold together Complementary goods. Playstation and ps4 games. 

 

income elasticity of demand

Acronym: YED

DefinitionThis is how responsive the quantity demanded by consumers of a product is to a change in income of the consumers

YED=% change Quantity demanded of product A%Change Price of product B

Value What it means Type of good Example
YED>0 An increase in income of consumers causes them to want to buy more of the good Normal good Most goods hence name normal. Expensive goods like sports cars, have high values. 
YED<0 An increase in income of consumers causes them to avoid the product Inferior good Budget goods. Pubic transport such as the bus, as if you can afford to buy a car you don't need the bus.

Price elasticity of supply

Acronym: PES

Definition: This is how responsive the quantity supplied is to a change in price of a product. 

PES = % change in Quantity supplied % Change in price

Editors

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