PED XED YED

Definition Price elasticity is a measure of the

responsiveness of the quantity of a good
demanded to changes in price.

Cross elasticity of demand is a measure of the
responsiveness of the demand for one good to a
change in the price of another good. It provides
us with information on the direction of change in
demand (whether it increases/decreases), and on
the magnitude of the demand shift.
Sign: +ve substitute
-ve complementary
absolute value >1 closely related/ <1 loosely
related
A measure of the responsiveness
of demand to changes in income. It
provide information on the
direction of change of demand,
given a change in income, and on
the magnitude of the change.
Sign: +ve = normal good, income
increasedd increase
- -ve= inferior good income
increase demand
decrease
- absolute value >1 = Y
elastic demand increase
by a lot
- <1 = Y inelastic demand
increases by small amount
Formula PED =


Sign /
Implications
For tax policy
1. Define indirect taxes/ Shift in
supply:
Imposition of a tax on a good has
the impact of shifting the supply
curve to the left. The curve will
shift from S
1
to S2 so that the
vertical distance between S
1
and
S
2
is equal to the amount of the
tax per unit of output. The new
after tax equilibrium occurs at
price P and quantity Q,
determined by the point of
intersection between demand
curve, D, and new supply curve
S2. The shaded area represents
the gov tax revenue, obtained by
multiplying amount of tax per unit
times the no. of units. tax
Price decision
1. business produces a line of products
similar / substitutes to each other. +ve
PED











- eg. Company producing Coca cola and
sprite
- Firm wants to increase revenue of selling
coca cola
What to produce during different
economic situations/ and how
much to produce for
manufacturing goods










1. During recession
Increase production of interior
good/ reduce production of
normal good
- define: inferior good, YED<0:
revenue is higher in the case of
inelastic demand
2. Define tax incidence:
Tax incidence is the study of who
bears the economic burden of a
tax. Broadly put, it is the positive
analysis of the impact of taxes on
the distribution of welfare within a
society

3. PED < 1 - Inelastic
- percentage change in quantity
demanded is smaller than the
percentage change in price.
Demand is said to be price
inelastic.















- Tax incidence - falls on
consumers
- producers are able to push the
tax incidence to the consumers

4. PED >1 Elastic
- percentage demanded is larger
- Firms look at PED of coca cola to determine
if a price cut will lower or raise total revenue
from coca cola
- If + PED<1, revenue will be increased when
price increases BUT
- It must consider the XED of demand,
relationship of these products when making
decisions about prices.
- knowing that the two goods are substitutes,
a fall in price in Cocacola will be followed by
a fall in demand for sprite.















- XED for coca cola and sprite it is not
enough to know that the XED >1. If the XED
is positive but low, percentage decrease in
price of coca cola will produce only a small
percentage drop in demand for sprite, so
the sale of sprite would not be seriously
affected. Therefore, increase coca cola will
increase revenue if PED < 1.
- XED of coca cola and sprite is high fall in
price of coca cola will produce a large drop
in demand for sprite increase sales of
coca cola come at the expense of sprite
demand curve shift rightwards
when income falls
- In a recession income falls
demand curve shifts from D1 to
D2.
- Egg. Of interior good small
cars
- At the same time, reduce
production of normal good
- Define: normal good, YED>0:
demand increases as income
increases, falls, as income falls.
- In a recession demand curve
shifts leftwards from D1 to D2.
- Eg. In a recession, producers
increase production of small
cars, reduce production of luxury
cars
- The extent of shift in demand
depends on the value of YED. It
tells producer how much to
increase or decrease in the
production of a good.
- YED > 1 demand shifts
leftwards by a large extent
producers increase production
by a lot
- YED<1 producers increase
production by a little
-
2. Economic boom
- same thing but in reverse
order
- increase production of normal
good, decrease production in
inferior good
How to increase income for
primary commodities
than percentage change in price
demand is price elastic,
producers are unable to push tax
incidence to consumers











5. PED = 1 (unit elastic) - %change
in quantity demanded = %
change in price

6. PED = 0 (perfectly inelastic)
percentage change in quantity
demanded = 0

7. PED = infinity (perfectly elastic)
change in price results in an
infinitely large response in
quantity demanded

Firm pricing decisions
- relationship between PED and total
revenue shows that business must
take PED into consideration when
considering changes in price of their
product. PED varies along the
demand curve
- Total revenue is the amount of
money received by firms when they
sell a good and is equal to the price
sale company would want to avoid.

Predict the effect on sales of good due to
changes in price of substitutes provided by
rival business










- Coca cola would be interested in knowing the
XED between coca cola and pepsi. Coca cola
would want to predict the effect on Coca cola
sale of any change in the price of pepsi.
- Explain graph - Large XED would mean that if
pepsi dropped its price, coca cola will suffer a
serious drop in sale, low XED means that coca
cola would not be seriously affected.

Collaboration with other firms
1. Substitutes and mergers between firms
- merger takes place when two firms unite to
form a single firm. Business that produce close
substitutes, high XED are interested in
merging because that way they would
eliminate the competition between them.
knowledge of XED of goods produced by rival
firms interested in merging can be used to
determine whether the merger should be
permitted to take place.

2. Complementary goods
- products that have lower XED are weakly



1. Primary goods
- +YED<1, income inelastic ,
the increase in income is
relatively smaller than
manufacture goods
- Make good for income
elastic to increase income
diversify eg. Coffee beans
coffee planters can
diversify, value add, process
its coffee beans, to make it
more income elastic, so that
the demand curve will shift
rightwards in to a larger
extent.
of the good times quantity of the food
sold. TR=PxQ

1. Demand is elastic PED>1
- increase in price causes a fall in total
revenue, decrease cause rise in total
revenue











- 10% price increase larger than
10%decrease of quantity demanded.
TR falls
- At the initial price and quantity P1
and Q1, total revenue is given by the
sum of rectangles a and b. When
price increases to P2 and quantity
drops to Q2, total revenue is given by
the sum of the rectangles A and C.
Rectangle B was lost and the
rectangle C was gained. Loss of B is
larger than the gain C, total revenue
fell.
2. Demand is inelastic PED <1

- percentage change in quantity
demanded is smaller than the
percentage change in price.


complementary and will not be much interest.
High negative XED means that lowering the
price of one good can result in a significant
increase in demand and sales of the other.
- Prompts collaboration between businesses
that produce complementary goods. Sport
clothing and sport equipment are highly
complementary as charter flights are likely to
produce a significant increase in holiday
hotel occupancy.










- increase in price causes increase in
total revenue
- 10% price increase will produce a
smaller than 10% decrease in
quantity demanded.
- Bottom right portion of the demand
curve is where demand is inelastic.
P increase total revenue gain,
rectangle C, is larger than total
revenue lost, rectangle B.
- Price falls from P2 to P1, percentage
price decrease give rise to smaller
percentage price decrease give rise
to smaller percentage increase in
quantity demanded and total revenue
fall
- Gain in total revenue, rectangle B, is
smaller than the loss, rectangle C,
revenue falls
Conclusion If a business wants to increase its total
revenue, it must decrease its price if
demand is elastic, or it must increase its
price if demand is inelastic.

Determinants
Explain eg.
Of elastic and
inelastic
Substitutes
- More substitutes an increase in its
price will make consumers switch to
other products that satisfy the same
need relatively large drop in
Relationship of the goods + closely related or
not
1. Substitute
- define: A product or service that satisfies
the need of a consumer that another
Nature of the good
1. Normal good
- define: a good the demand
or which varies directly with
income. As income
quantity demanded more elastic will
be its demand
- Eg. Many brands of toothpaste, all of
which are close substitutes of each
other. Increase in price of one brand,
with prices of all the others remaining
the same consumers switch to
theses others large drop in quantity
demanded of the more expensive
toothpaste following increase in price.
- Eg. Inelastic eg. Increase in price of
petrol likely to give rise to a small drop
in quantity demanded goods have
few substitutes, then an increase in
price will bring forth small drop in
quantity demanded

Luxury of necessities
- necessities goods essential in our
lives demand for goods less elastic
than demand for luxuries
- eg. Demand for medications
inelastic peoples health depend on
it
- Luxury indispensable eg.
Diamond rings

Length of time
- longer the time period in which a
consumer makes a purchasing
decision elastic
- consumers are able to get information
on the availability of alternative to the
good
- eg. Heating oil consumers can do
little to switch to other forms of heating
in a short period of time inelastic
over short periods of time. As time
product or service fulfills. Egg. Pepsi and
coke
- consumers can switch to cheaper
substitutes
Diagram:























2. Complementary
- define: two goods needed to be consumed
together to enjoy a utility eg. Camera and
SD cards
- consumer reduce consumption of the two
products
- diagram
increases dd increases.
- Egg. Luxury car
- Draw diagram














2. Inferior good
- define: demand for which
varies inversely with
income. Income increases,
dd decreases.
- Egg. Small cars
goes by switch to other heating
systems, such as gas elastic

Proportion of income spent on good
- larger the proportion of ones income
needed to buy a good more elastic
demand
- eg. Summer holiday vs pen
- response in quantity demanded is
likely to be greater in the case of
summer holidays than in the case of
pens
Addiction
- greater degree of addiction, more
inelastic demand