9 Questions
If the cross price elasticity of demand (XeD) between two goods is calculated to be 2.5, how would you interpret this?
The goods are substitutes
What does it mean when the income elasticity of demand (IED) for a product is calculated to be -3?
The product is a luxury good
If the cross price elasticity of demand (XeD) is calculated to be 0.1, what type of relationship do the two goods have?
Complementary goods
When the elasticity of demand is between 0 and -1.00, how would you describe the demand?
Inelastic
What can be inferred about two goods if the XeD is calculated to be -0.8?
They are substitutes
If the IED for a product is found to be 1.5, how should the nature of the product be classified?
Luxury good
When interpreting an elasticity of demand that is infinite, what does this indicate about the demand?
Perfectly elastic demand
If the XeD between two goods is calculated to be -1.2, how would you classify the relationship between these goods?
Substitute goods
What does an IED value of -0.7 indicate about a product?
It is an inferior good
Study Notes
Price Elasticity of Demand (PED)
- PED measures the responsiveness of demand for a commodity to changes in its price
- PED = % change in quantity demanded / % change in price of the good
- Example: 20% increase in price leads to a 10% fall in quantity demanded, PED = 0.5
- Example: 10% increase in price leads to a 90% decrease in quantity demanded, PED = 9
Determinants of PED
- Substituted products: easily substituted products have elastic demand, while those that cannot be substituted easily have inelastic demand
- Necessity products: necessities have inelastic demand due to few substitutes
- Luxury products: luxury products have elastic demand due to many substitutes
Income Elasticity of Demand (IED)
- IED measures the percentage change in quantity demanded with respect to the percentage change in income of the consumer
- IED = % change in quantity demand / % change in income
- Example: 2% rise in income causes an 8% rise in demand, IED = 4
Cross Price Elasticity of Demand (XED)
- XED measures how demand reacts to changes in the price of other goods
- XED = % change in quantity demanded of main good / % change in price of other good
- Example: 2% rise in demand for butter when the price of margarine rises by 8%, XED = 0.25
- If XED is positive, goods are substitutes; if negative, goods are complements
Supply
- Supply refers to the amounts of a good producers are willing and able to sell at a given price
- Market supply curve: total quantity all producers are willing and able to produce at different prices
- Supply curve is always upward sloping (positive)
Shifts in the Supply Curve
- Variables that shift the supply curve: input prices, technology, number of firms, substitutes, and expectations of future prices
- Example: drought leads to less fruit harvested, supply curve shifts inward (to the left)
Supply Shifters
- Number of suppliers: more entrants means more supply at a given price, supply curve shifts to the right
- Technological advances: cheaper production leads to supply curve shifting to the right
- Input prices: increase (decrease) in key input price shifts supply curve to the left (right)
Elasticity Interpretation
- Єd between 0 and -1.00: inelastic demand
- Єd between -1.00 and infinite: elastic demand
- Єd = -1.00 or 1.00: unit elastic demand
- Єd = infinite: perfectly elastic demand
- Єd = 0: perfectly inelastic demand
Test your knowledge on the concept of price elasticity of demand, which measures the responsiveness of demand for a commodity to changes in its price. This quiz includes examples calculating price elasticity based on percentage changes in price and quantity demanded.
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