ELASTICITY

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PRICE ELASTICITY OF DEMAND- PeD

Formula: % Change in Qty demanded / % Change in price

Measures the responsiveness of demand for a product following a change in its own price

ALWAYS NEGATIVE

PeD= 0= Perfectly inelastic, meaning demand will not change at all when the price changes

PeD= between 0 and 1= Inelastic, meaning the change in demand is less than proportionate to the change in price

PeD= 1= Unit elastic, meaning the change in demand is the same as the change in price

PeD= >1= Elastic, meaning demand responds more than proportionately to a change in price

Where the change in demand > change in price, demand = elastic

Where the change in demand < change in price, demand = inelastic

Determinants of PeD-

The number of close substitutes for a good/ uniqueness - the more substitutes, the more elastic because consumers can easily switch their demand

Cost of switching - the more costs there is the more relatively inelastic demand is

The degree of necessity or whether it is a luxury - necessities are more inelastic whereas luxuries are elastic

The % of income allocated on spending on the good

The time period allowed following a price change - the longer consumers are given the more demand is price elastic

Whether the good is subject to habitual consumption - consumers become much less price sensitive e.g. addictive cigarettes

Peak and off-peak demand- demand is price inelastic at peak times

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PRICE ELASTICITY OF SUPPLY- PeS

Formula: % Change in Qty supplied / % Change in price

Measures the relationship between change in quantity supplied and a change in price

The value of elasticity of supply is positive, because an increase in price is likely to increase the quantity supplied to the market

Determinants-

Spare capacity - if there is plenty, output should be able to quickly increase and therefore is elastic

Stocks - If stocks are high firms will be able to respond to changes in demand quickly and therefore is elastic

Ease of factor substitution - How easily you can respond to sudden changes in demand (E.G. sudden increase in demand for petrol canisters during the recent fuel shortage), if capital and labour is occupationally mobile then YeS is likely to be higher

Time period - Supply is likely to be more elastic, the longer the time period a firm has to adjust its production

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CROSS PRICE ELASTICITY OF DEMAND (XPed)

Formula: % Change in Qty demanded (Good A) / % Change in Price (Good B)

Measures the responsiveness of good A following a change in price B

The stronger the relationship between two products, the higher the co-efficient of cross-price elasticity of demand- close substitutes or compliments will have a high cross-price elasticity. Products with no relations have a zero cross elasticity

Goods which are complements will have a negative XPed sign

Goods which are substitutes will have a positive XPed sign

Businesses use of XPed-

Pricing strategies for substitutes- If a competitor changes its price firms need to consider how many consumers will switch? will they have the capacity to meet a rise in demand? Will the other firm match a price rise? EXAMPLE- Historically this occurred with the rapid expansion of low-cost airlines

Pricing strategies for complementary goods- A discount on one good will see a rise in demand for its complement which is likely to compensate to the lower cost of good A, therefore not lowering profit.

Advertising and Marketing- customer loyalty and habitual purchases will decrease the XPed of rival goods and therefore reduces the size of the substitution effect.

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INCOME ELASTICITY OF DEMAND - YeD

Formula: % Change in Qty demanded (good X) / % Change in real income

Measures the responsiveness of quantity demanded to a change in income

Normal goods - positive YeD meaning as income rises more is demanded

Necessities - YeD= between 0 and +1 meaning demand rises with income, but less than proportionately because we have a limited need to consume additionally quantities of necessary goods; we would buy it even if our income didn't rise. E.G. Vegetables, utilities, sanitation products (income inelastic)

Luxuries - YeD= > +1 meaning demand rises more than proportionate to a change in income. Also known as "positional goods"- products which are consumed to derive satisfaction from being seen as a customer. E.G.- Designer clothes, private education, private healthcare (income elasticity)

Inferior goods - Negative YeD meaning demand falls as income rises. This is often because consumers switch to preferred more expensive alternatives, during a recession inferior products may grow. e.g. own brand soap, tinned meat, bus travel (Negative elasticity)