A) Price, income and cross elasticities of demand

Price elasticity of demand (PED) measures the responsiveness of quantity demanded to a change in the price of the good or service.

Income elasticity of demand (YED) measures the responsiveness of quantity demanded to a change in consumers’ income.

Cross elasticity of demand (XED) measures the responsiveness of demand for one good to a change in the price of another good.

B) Calculating elasticities of demand

The three elasticities can be calculated using percentage changes in quantity demanded and the relevant variable.

C) Interpreting elasticity values

Price elasticity of demand

A relatively inelastic good has a quantity demanded which responds less than proportionately to a change in price. A relatively elastic good has a quantity demanded which responds more than proportionately to a change in price.

A PED of -1 is known as unitary elastic demand, where the percentage change in quantity demanded is equal to the percentage change in price.

Income elasticity of demand

A negative YED indicates an inferior good, where demand falls as income rises. A positive YED indicates a normal good, where demand rises as income rises.

Cross elasticity of demand

A positive XED indicates substitute goods. A negative XED indicates complementary goods, while a value of zero indicates that the goods are unrelated.

D) Factors influencing price elasticity of demand

• Availability of substitutes – If there are many similar substitutes available, demand is likely to be more price elastic because consumers can switch to another product if the price rises.
• Luxury or necessity – Demand for luxury goods is generally more price elastic because consumers can choose to go without them. Necessities tend to have more price inelastic demand.

E) Why elasticities of demand matter

Understanding elasticity can help firms and governments predict how consumers are likely to respond to economic changes.

For example, a firm may want to know how strongly demand will respond to a change in price, while a government may consider elasticity when deciding whether a tax or subsidy is likely to change consumption significantly.

What the full guide adds

For this topic, the full AS guide also covers:

• The full interpretation of PED values, including perfectly inelastic, relatively inelastic, unitary elastic, relatively elastic and perfectly elastic demand.
• More detailed interpretation of YED and XED, including income-elastic and income-inelastic demand, inferior goods, normal goods, substitutes, complements and unrelated goods.
• Additional factors affecting PED, including the percentage of income spent on a good and the time period available to consumers.
• How firms and governments use elasticity when considering indirect taxes and subsidies, changes in real income, and changes in the prices of substitutes and complementary goods.
• The relationship between price elasticity of demand and total revenue, including what happens to revenue when prices rise or fall for elastic and inelastic products.